Why does the smart money keep flunking Investing 101?
During the 2008-09 global financial crisis, many of the world’s biggest investors found themselves in dire need of cash because they had sunk too much money into assets that couldn’t be publicly traded.
Now they’ve made the same mistake all over again.
Over the past couple of decades, no group of investors has piled into so-called alternative assets more eagerly than the endowment funds of major colleges and universities. In their rush to emulate the stellar success of Yale University’s endowment head David Swensen, who died in 2021, educational institutions pulled tens of billions of dollars out of stocks and bonds and poured it into hedge funds, private equity, venture capital and other investments that don’t trade publicly.
The result looks nothing like the portfolio of 60% stocks and 40% bonds that has long been a guidepost for many investors. On average, in fiscal 2024, educational endowments with more than $5 billion in assets held only 2% in cash, 6% in bonds, 8% in U.S. stocks and 16% in international stocks, according to the National Association of College and University Business Officers. That left two-thirds of their total holdings in private funds and other non-traditional assets that can’t readily be turned into cash.
Now you understand the life-or-death panic that seized such elite institutions as Brown, Columbia, Cornell, Harvard, Northwestern and other universities when the Trump administration threatened to cut off their federal funding. Even though their endowments hold billions of dollars, much of that immense wealth might as well be stored on the planet Proxima Centauri b, about 4.2 light years away.
These universities are slashing budgets, freezing their hiring and scrambling to raise money any way they can.
Brown, whose endowment assets exceed $7.2 billion, had to borrow $300 million in April and an additional $500 million in July “to protect the university against worst-case financial scenarios,” it said this month. Northwestern, with its $14.3 billion endowment, borrowed $500 million earlier this year; Harvard, with its titanic $53.2 billion endowment, raised $750 million in April.
To be fair, much of the money at endowments is restricted, meaning it can be spent only for prespecified purposes. But that’s all the more reason why putting so much of it in nontraded assets is a bad idea.
The saddest part of this sad saga is that it’s déjà vu all over again. “A recent survey of college and university presidents found that 50% have, or will soon, put in a hiring freeze,” I wrote in 2009. “Nearly 7% admitted selling assets into a bear market; another 9% have been forced to borrow money at punitive rates.”
The lesson is so simple even Ivy Leaguers should be able to understand it.
In good times, investors give no thought to liquidity, because cash is plentiful and the need for it isn’t pressing.
In hard times, liquidity becomes the only thing investors can think about, because cash is scarce and the need for it is desperate.
And when you have a sudden, urgent need for cash, good luck selling your alternative assets.
Yale—which started the whole craze for alternative assets decades ago—has reportedly been seeking to sell several billion dollars in private-equity funds for more than a year. The Wall Street Journal has reported that the funds are expected to sell for less than their stated value.
This spring, after months of effort, Harvard sold $1 billion in private-equity funds at about a 7% discount to their stated value, the Journal has also reported.
Note that this retrenchment is recurring amid one of the biggest bull markets in history. Just imagine how hard it would be for these institutions to raise cash if public markets were crashing, as in 2008-09, or if interest rates were skyrocketing, as in 2022.
Back in 2007, Laurence Siegel, then research director for the Ford Foundation’s endowment, analyzed what would happen if institutional investors that had gorged on alternative assets suddenly needed to raise cash.
An endowment that had sold most of its bonds to fund the purchase of private assets, as many already had done by then, would have to sell its publicly traded stocks if it had to raise cash, he wrote.
In a bear market for stocks, Siegel warned, an institution with 50% of its assets in alternatives could run out of cash in as little as two years.
Nobody listened.
Within months, many institutional investors suffered their worst losses since the 1970s—and often turned those paper losses into real ones, selling their most liquid assets into a market panic.
What the university “smart money” should have learned is that liquidity is priceless and must never be taken for granted.
And that’s why investors, no matter how large or small, should never put most of their assets into illiquid securities. No one can possibly predict when public markets will crash or public officials will take unprecedented action, turning private assets into albatrosses.
Of all the ailments investors suffer, amnesia is the most deadly. What happened less than 20 years ago feels as if it took place in ancient Mesopotamia. As Siegel told me this week, instead of learning the obvious lessons of 2008-09, university endowments “just doubled down.”
But, I protested, aren’t they supposed to be the smart money?
“They’re not as smart as they look,” Siegel said, “because they’re human, and humans are quite closely related by evolution to monkeys.”
Don’t be a monkey. Don’t put a penny into alternatives that you can’t afford to have locked up when you suddenly need cash.
Write to Jason Zweig at intelligentinvestor@wsj.com