Felix Salmon clarifies some of the real reasons university endowments are dumping private equity stakes:
The problem with private equity funds is not that they're illiquid, or that they're long-term: endowments can cope with both of those quite easily. Rather, it's that they're highly levered, which means that they can go to zero quite easily. And once they've hit zero, they don't ever recover.
Leverage is fantastic on the way up since it multiplies gains, but downright brutal on the way down, since it multiplies those too.
The common 2 and 20 fee structure (2% of assets and 20% of gains above some benchmark), is not very attractive at the moment either. After all, who wants to pay 2% for the privilege of watching their portfolio shrink?
These funds were the cream of the crop of the financial world. When things were going well, their past performance eased worries, allowing them to increase leverage, which increased performance... But that all came to a screeching halt when the market stopped going up.
Hmmm...Perhaps it's just because a reporter called yesterday about the Tuition Bubble paper I wrote a few months ago, which compared the housing bubble to what I called a tuition bubble, but I see some similarities here. Replace leverage with prestige, and equity funds with the top schools in the country, and you've got a very similar situation. These schools rely heavily on their prestige (leverage) to succeed. Their performance appears to justify their high tuition (2 and 20 fees). As long as nothing damages their prestige, they are in a virtuous cycle of prestige leading to more money leading to more prestige...
Q: Is there anything that could damage the prestige of these institutions?
A: Value added assessment of the education they provide. While some of the top schools are doing a good job, I have little trouble imagining some are resting on their laurels.
Even at our best schools, we do not currently have value added assessment, as this quote from William R. Fitzsimmons, dean of admissions at Harvard shows:
At Harvard we get terrific students, and we turn out terrific students later on. Is that due to Harvard or is that due to the students to begin with? Who knows?
Given that value added analysis could upset the virtuous cycle, it should come as no surprise that top schools energetically resist it. As Kevin Carey notes, "When the conventional wisdom says you're the best, you have no interest in proving otherwise." Their best interests "lie in using whatever means necessary to prevent the release of any information that would upset the status quo." A proposal a few years back that would have moved us one step closer to value added failed when
lobbyists for private colleges put on a full-court press to block the proposal, pressing Congress to prohibit its creation and publicly denouncing it as "Orwellian" and "an assault on Americans' privacy and security in the shadow of the Fourth of July."
Value added assessments will not be blocked forever. And on the wonderful day when it comes, schools that perform poorly will shut down because no students will want to attend a school that doesn't provide value. Schools would be well advised to make sure they will perform well on this measure by ensuring they are providing value for their students, which means shifting away from the sorting/screening and entertainment functions that seem so dominant today, and towards a system that focuses more on educating and guiding students.
Luckily, as these universities ditch high fee funds relying on leverage, they are getting a glimpse of what lies in their future if they cease to earn their prestige, and rely on their illustrious past to carry them forward.