The secondary market for private equity stakes is witnessing a significant surge, with notable institutions like Harvard and Yale capitalizing on the trend as they offload portions of their private equity portfolios. This strategic move comes amid a pressing demand for liquidity and flexibility, prompted by extended timelines for returning capital to investors and broader economic uncertainties.
In a surprising twist, both selling institutions and buyers are expected to benefit from these transactions, even as elite universities like Harvard and Yale sell their stakes at a discount relative to current market valuations. The unfolding scenario raises questions about the long-term sustainability of returns within the often opaque realm of private equity, with industry experts suggesting a shift in sentiment may be on the horizon.
Despite any conjectures linking these sales to potential challenges tied to university finances, including possible tax implications on endowments, the motivations for these divestitures appear largely rooted in fiscal strategy. Nir Kaissar, founder of Unison Advisors, noted in a Bloomberg opinion piece that the current market dynamics may reveal deeper issues about the performance of private equity investments.
University endowments are generally regarded as ideal players in alternative asset classes. With extended investment horizons, they are well-positioned to weather the volatility that often accompanies public market investments. Harvard’s endowment, valued at approximately $53 billion and heavily weighted toward private equity exposure, faces scrutiny over whether its valuation accurately reflects the underlying realities of current market conditions.
Kaissar pointed to historical performance metrics that show private equity index returns of 9.4% annually from 2007 to 2024, with a comparatively low volatility measure of 7.2%. In contrast, the S&P 500 yielded a slightly higher return of 10.5% but exhibited significantly greater volatility with a standard deviation of 16.8%. While these figures might suggest that private equity provides a more stable investment opportunity, they could also obscure potential pitfalls inherent in how valuations are established in the private market.
Investment expert Tim McGlinn emphasized that unlike publicly traded companies, the valuations assigned to private equity assets rely heavily on subjective estimates, which may not necessarily reflect their true market worth. Consequently, there is a growing concern that the difference between perceived value and actual value could lead to significant disparities when firms attempt to exit their investments.
The implications of this distinction are profound. Jason Reed, finance professor at the University of Notre Dame, explained the correlation between public and private asset performance. When the broader economy thrives, exits from private equity investments tend to increase. Conversely, during economic downturns, opportunities for selling such assets diminish, thus straining the potential for returns.
In recent months, Harvard Management Company agreed to sell around $1 billion of its private equity holdings. This decision mirrors a prior disinvestment made in the summer of 2021. The university’s financial report highlighted the need to make these adjustments in response to market dynamics and liquidity requirements. A spokesperson for the investment office at Yale stated that the university is in discussions to liquidate nearly $3 billion in private equity stakes at discounts below 10%. The institution, which has been a pioneer in alternative asset investing, has allocated 95% of its $41 billion endowment to growth-oriented investments such as private equity and venture capital.
The ongoing sales are not indicative of distress but rather appear to be calculated actions informed by financial reviews. McGlinn argued that given Yale’s reputation in the investment arena, the university is likely securing a favorable deal.
Both universities’ actions reflect a broader trend among limited partners in private equity, who have been selling their stakes at an average 11% discount relative to the reported net asset values. This trend has intensified even as valuation scores seem to decline amid high borrowing costs. Nevertheless, secondary market activity has surged, with sales increasing 45% to a total of $162 billion last year, indicating an appetite for such trades.
In light of this demand, Harvard and Yale may find themselves minimizing losses on these transactions, potentially selling stakes for more than their original investment commitment despite the discounts. McGlinn suggested that many buyers might be inclined to overvalue assets temporarily. This phenomenon, known as “NAV squeezing,” allows secondary funds to reclassify these investments at previously assigned net asset values, leading to artificially inflated returns. According to reports, such maneuvers can lead to astonishing one-day returns, sometimes exceeding 1,000%.
While some financial professionals caution against drawing parallels to Ponzi schemes, concerns about the sustainability of these practices remain poignant. Jeffrey Hooke, a senior finance lecturer at Johns Hopkins University, noted that the mechanics of this accounting practice provide a mere veneer of stability over what may be a precarious situation.
The key takeaway from these developments is that while elite universities like Harvard and Yale aim to maintain a robust investment strategy that incorporates a significant allocation to private equity, the evolving landscape presents challenges that cannot be ignored. Institutions may indeed navigate their current disbursements while maintaining equity in their portfolios, yet the shifting tides of private equity valuations and market dynamics warrant careful scrutiny moving forward.
As the financial world increasingly scrutinizes these asset classes, the experiences of such prestigious universities may offer valuable insights into the broader implications for institutional investments and the evolving relationship between private and public market dynamics.