Cash Me If You Can

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"Institutions were attempting to emulate the Yale model because it seemed to make sense," says the chief investment officer for a university with a billion-dollar endowment. "Now this is the squeeze that everybody's in. Were we wrong to go into this asset class? Is the asset class dead forever? Do we have to change the model going forward? These are all questions people are grappling with."

David Salem regards Swensen as a mentor. He is the founding president of The Investment Fund for Foundations, or TIFF, which manages approximately $7 billion for more than 700 nonprofits, including Harvard, Stanford, and Yale-New Haven Hospital. The two men are occasional squash partners; Salem is the better player, and Swensen doesn't like to lose. After one defeat, Swensen brooded during dinner and finally interrupted an unrelated conversation with Salem to exclaim, "Damn, I should have won that point!"

Over a virtuous lunch of grilled-chicken salad in TIFF's Harvard Square office late last year, Salem told me that many endowments "slavishly imitated" Yale. "It's hard for institutions that haven't been as successful as Yale to resist the temptation." The Yale model is probably "true over time," he added. "But in calendar '08, it's exactly wrong. The less liquid you are, the more you're getting hurt."

Nevertheless, Yale doesn't seem to be hurting as much as some of its imitators. That's because Swensen, it turns out, hasn't always followed his book's advice. He pursued success and liquidity, employing lessons he had learned from prior bubbles and crashes to ensure ready access to cash. Now, with his counterparts at other top colleges dumping private equity investments in a panic, Swensen, ever the contrarian, is looking to buy more. Those who know him would expect nothing less.

At Ted Smith's going-away party in 2003, his co-workers at the University of Virginia's endowment management office presented the analyst with two keepsakes. Predictably, one was a pewter cup in the style designed by UVA founder Thomas Jefferson and engraved with the university's rotunda logo. The other was a book: Swensen's Pioneering Portfolio Management, signed by Smith's colleagues on the front and back flyleaves.

That gift, Smith says, "tells you something about how things were" at Virginia in that era. Its investment staff couldn't escape the Swensen doctrine. In May 2000, the month that his book was published, Swensen spoke at a board meeting of the university's management arm. UVA's investment brass made Pioneering Portfolio Management required reading for every employee. And in 2002, the previously conservative university targeted a startling 85 percent of its endowment toward alternatives.

The Yale model was "very, very influential" at Virginia, says Henry Kaelber, chief financial officer of the university's investment office from 1997 to 2003. "Everybody respected, recognized, and saw great results from the Yale model." Today, UVA epitomizes the predicament of Swensen's acolytes-particularly in its overexposure to private equity. Normally, it takes years for an endowment to build up significant private equity holdings. That's because when an endowment pledges a certain sum to private equity managers, they don't invest all the money at once. Instead, they ask for it gradually as suitable opportunities arise to buy companies.

But Virginia and other universities tried a shortcut, outlined in a 2001 article by two of Swensen's top lieutenants.

The schools pledged sums to private equity that far exceeded their investment targets. Although Virginia set a target of investing 20 percent of its endowment in private equity, it committed 35 percent, or $1.8 billion. The rationale was that the actual investment wouldn't substantially exceed 20 percent because as the outside managers gradually drew down the money, the university's coffers would be replenished by returns from IPOs of companies that the funds had bought. This approach, says an endowment insider, "is precisely why we are where we are today-why UVA is crunched."

When the market soured, Virginia couldn't rely on revenues from successful buyouts to pay its obligations, since IPOs have dried up. In addition, some of its private equity investments tumbled in value, such as its stake in a 2004 Bain Capital fund that acquired now-struggling retailers like Toys R Us in highly leveraged deals. Nervous endowment officials announced plans to fund capital calls by selling $400 million apiece in stocks and hedge funds.

The university has also cut spending and frozen salaries.

UVA officials maintain that the university has ample cash to meet its obligations. But Kaelber says the university increased its holdings in private equity too fast. "The word that comes to mind is overindulgence," he says.

Graying but still boyish at 55, Swensen wears his devotion to Yale on his chest, his lanky frame comfortably encased in a fleece athletic vest with Yale insignia. Yet underneath, he remains the blunt, cocky outsider who stormed New Haven as a graduate student in 1975. Back then, he rebelled against the snobbery of a Yale-sponsored wine tasting and organized a beer tasting, which proved so popular that it has become an annual event.

Swensen has just returned from London, where he vied with several money managers in an all-night session of a particularly fiendish poker variant called Beirut. When I ask if he was a winner, he just grins. Swensen is an animated talker, rubbing his hands together or gesturing out the window of his office toward the university's administration building. Normally, he works alongside his 22 staffers, who monitor the endowment's performance. The bulk of the money is actually invested by outside fund managers whom Swensen handpicks through a vaunted process of extensive interviews, research, and other due diligence.
Swensen tells me that Yale is about to break precedent and announce endowment results before the end of the fiscal year. They aren't good: down 25 percent, to $17 billion from $22.9 billion. He concedes that the economic crisis has identified "real weaknesses" among some of Yale's outside managers, including one who put together a land-development fund without enough capital.

On the other hand, Swensen points out, he's still beating the stock market, which has slid by an even greater amount. When critics deride the performance of alternative investments, "they aren't asking, 'Relative to what?' Hedge fund returns are negative. That's very disappointing, but they're still far superior to equity returns," he insists, spinning the numbers like a campaign manager. Although it's too early to evaluate how private equity has done, he adds, "I'd bet, two or three years from now, when we look back, high-quality private equity managers will produce superior returns" to public equities.

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