David Swensen, chief investment officer of the Yale University Investment Office, has signalled that the Yale Endowment may look to cut its exposure to private equity investment when the Yale advisors meet later this year.
Swensen, a staunch advocate of diversified fund strategies in which private equity plays a key role, says he is likely to recommend a reduction in private equity when the Yale committee meets in June 2002. “We currently aim to assign around 25 per cent of our funds to private equity investments. My inclination is that this should be reduced to around 20 per cent of the endowment.”
A risk adjustment study carried out by Yale highlighted the temptation to evaluate private equity returns without incorporating risk. “We looked at the returns achieved by successful buyouts (36 per cent net) and tallied them with the returns generated by an equivalent investment in the S&P 500 (17 per cent). The difference was significant, but when we incorporated the risk element of buyouts in comparison to the S&P 500, the S&P produced returns of 86 per cent.”
The Yale fund hit its target of 25 per cent commitment to private equity in 2000, although due to the subsequent market downturn, write-downs and distribution this figure currently stands at around 17 per cent. He added that many other university funds ought to increase their commitments to private equity investments in order to achieve the necessary exposure to the asset class.
One of the major themes of his speech concerned the level of management fees currently earned by general partners. He expressed concern that such fees can become an excessive priority for GPs. “It is possible that GPs will be less inclined to display their aggressive qualities when pursuing investments if the failure of an investment is likely to endanger their access to future management fees.”
Swensen highlighted the contrasting nature of smaller and larger funds. “We have seen a shift towards larger funds in the $1-1.5bn dollar range in recent years. In my opinion size is the enemy of performance. It would be interesting to turn the clock back to 10-15 years ago when fund sizes were of a more manageable size. Smaller VC funds are much better positioned to land double-digit multiples.”
The Yale CIO also looked at the Yale Endowment results over recent years. In the year to June 2000, Swensen generated a 41 per cent return ($3bn) largely due to a raft of private equity successes at the height of the tech boom. In the same period for 2001, he the fund produced a 9.2 per cent return. “In many ways I was more thrilled by the 2001 results than those registered in 2000. It confirmed to me that a diversified and well-managed portfolio could produce strong results in a downturn.”