A recent headline in the Dartmouth student newspaper reads, “Dartmouth’s endowment posts 46.5% year-over-year returns, prompting additional spending on students”. That seems like really great investing performance. But the sub-headline dismisses it as less-than-stellar, by comparison: “The endowment outpaced the stock market, but fell short when compared to other elite universities that have announced their endowment returns.” After all, fellow Ivy League university Brown notched a 50% return for fiscal 2021, which in turn was surpassed by Duke University at 55.9% and Washington University in St. Louis at 65%. The Harvard endowment fund managers are a bit on the defensive for gaining “only” 34% on the year.
The stock market has done well in the past year, but nothing like these results. What is the secret sauce here? Well, it starts with having money already, lots of it. That enables the endowment managers to participate in more esoteric investments. This is the land of “alternative investments”:
Conventional categories include stocks, bonds, and cash. Alternative investments include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts. Real estate is also often classified as an alternative investment.
It takes really big bucks to buy into some of these ventures. Inside Higher Ed’s Emma Whitford notes:
Endowments valued at more than $1 billion, of which there are relatively few, are more likely to invest in alternative asset classes like venture capital and private equity, recent data from the National Association of College and University Business Officers showed.
“Where you’re going to see higher performance are the institutions with endowments over a billion,” Good said. “If you look at the distribution of where they’re invested, they have a lot more in alternative investments — in private equity, venture capital. And those asset classes did really well. Those classes outperformed the equity market.”
In most cases, you have to be an “accredited investor” (income over $200,000, or net worth outside of home at least $1 million) to start to play in that game. From Pitchbook:
Private equity (PE) and venture capital (VC) are two major subsets of a much larger, complex part of the financial landscape known as the private markets…The private markets control over a quarter of the US economy by amount of capital and 98% by number of companies….PE and VC firms both raise pools of capital from accredited investors known as limited partners (LPs), and they both do so in order to invest in privately owned companies. Their goals are the same: to increase the value of the businesses they invest in and then sell them—or their equity stake (aka ownership) in them—for a profit.
Venture capital (VC) is perhaps the more attractive, heroic side of this investing complex:
Venture capital investment firms fund and mentor startups. These young, often tech-focused companies are growing rapidly and VC firms will provide funding in exchange for a minority stake of equity—less than 50% ownership—in those businesses.
Some examples of VC-backed enterprises include Elon Musk’s SpaceX, and Google-associated self-driving venture WayMo.
Venture capital takes a big chance on whether some nascent technology will succeed (in the fact of competition) many years down the road, which has the potential to make the world a better place for us all. Other private equity operations can be more prosaic, predictable, and sometimes brutal. Here is putting it nicely:
Private equity investment firms often take a majority stake—50% ownership or more—in mature companies operating in traditional industries. PE firms usually invest in established businesses that are deteriorating because of inefficiencies. The assumption is that once those inefficiencies are corrected, the businesses could become profitable.
In practice, this often entails taking control of a company via a leveraged buyout, firing lots of employees (sometimes including the former management), improving some strategy or operations of the firm, and sometimes breaking it up and selling off the pieces. This was the fate of several medium-sized oil companies that got in the cross-hairs of corporate raider T. Boone Pickens. “Chainsaw Al” Dunlop also became famous for this sort of “restructuring” or “creative destruction”. The archetypical leveraged buyout/feeding frenzy/breakup with RJR Nabisco was chronicled in the classic Barbarians at the Gates.
These sorts of private equity operations are arguably beneficial to the economy by improving efficiencies, and are unarguable lucrative for the deal-makers. That said, is there any way for you, the little guy, to get a piece of this action? Unless you are an “accredited investor” as described above, and willing to commit sums on the order of $100,000 for five or so years, the answer seems to be no, you cannot directly participate in these sorts of deals.
However, there is an indirect way to participate: there are publicly traded companies who do this leveraged buyout stuff, and you can buy shares in these companies, and thereby share in the fruits of their pruning of corporate deadwood. Some names are: Kohlberg Kravis Roberts (KKR), The Carlyle Group (CG), and The Blackstone Group (BX). Blackstone is the behemoth of alternative investments, with $730 billion (that is closing in on a trillion dollars) of assets under management. The share prices of all these firms have more than doubled in the past year (100+ % return). If you had had the guts to plow your savings into any one of these private equity firms a year ago, you would have had the glory of beating out those university endowment funds with their piddling 50% returns.
Will these firms (KKR, CG, BX) continue to grow in earning and share prices? I don’t know, but I am thinking hard about it. This is supposedly smart money, and historically it has not paid to bet against Blackstone:
Share price of Blackstone (BX) for past ten years, plotted on log scale to better show its seemingly inexorable march upwards. Chart source: Stockcharts
Letters to Creationists 