The University Bubble

Steven Davidoff with an interesting analysis on the rising illiquidity effects of falling endowments:

In the short term, unless it boosts its liquid returns, Harvard is going to have to raise a lot in donations or eat up its liquid assets to fund university obligations and its private equity commitments. This results in a spiraling decline in Harvard’s liquid assets as each year they go lower to meet these needs and more and more assets become tied up in private equity. This assumes the markets stay where they are in the next three years — there are scenarios where liquid assets do worse (like yesterday), or better, of course.

This is likely why Harvard recently sold $1.5 billion in debt, and unsuccessfully tried to sell $1.5 billion of its private equity portfolio. It needs to cover short-term funding obligations rather than liquidate illiquid assets at fire-sale prices. In essence, Harvard is more like a hedge fund than ever — trading for short-term gain with the same risks involved.

Other universities may be in worse positions. Duke, for example, sold $500 million in bonds, and Princeton $1.5 billion. Again, the reason appears to be to fund liquidity.

The result is twofold. First, private equity may not have as much dry powder as people believe. Private equity investors, known as limited parters, or LPs, are likely to strongly resist meeting all of their commitments. This may lead to a renegotiation of some funds as private equity seeks to accommodate their clients.

Private equity was historically viewed as the savior to higher education, but it now may mean its trouble.

Second, there is education itself. To paraphrase “Top Gun,” “their mouths were writing checks their brains couldn’t cash.” Universities expanded rapidly during the past few years on the basis of endowment growth. But not only is that growth gone and endowments fallen, the numbers may be far worse because of how much these entities depend on private equity.

In the long term, this should all rebalance and dry powder gains may compensate, but as Keynes said, “in the long run, we are all dead.” The Yale model assumes that endowments have perpetual life, but they also have short-term funding commitments.