Monday, November 10, 2008

Endowments cutting back on PE?

According to PrivateEquityOnLine, Harvard University is in the process of looking to sell $1.5B of PE investments in the secondary market. With nearly $40B under management and 11% invested in PE, this represents around 1/3 of their PE stakes.

I am not sure this action has the hallmark of a hasty panic as indicated in Silicon Alley Insider. Following are comments to Henry's post earlier today http://www.alleyinsider.com/2008/11/the-cash-panic-sweeping-the-vc-industry :


1. While the PE market always has some defaulting LP's, and no doubt the % of defaults will rise in '09, it should not reach the epidemic proportions witnessed in '02-03. Many vintage '00-'01 funds had abnormally high % of investors as individuals/small family offices that were unable to meet capital calls or were margined too high due to lack of diversity of their portfolios. Professional institutions are indeed suffering today from being suddenly overweighted in PE (due to the 'denominator problem' that occurs when PE is tracked as a % of total portfolio value). If the portfolio value decreases, while the PE value remains constant, targets are overshot. By charter, this often triggers events to re-balance within proscribed formulas; which include sale of PE stakes and lower commitments to new managers. Institutional thinking often leads to a belief that the current pain of selling a portfolio at a 'discount' is less than the pain associated with being out of charter.

2. As for Harvard, I don't have any insider knowledge, but they have a reputation for being a market leader due to their early support of VC, and bold actions in the VC market. The later includes a proactive approach to limit exposure to VC funds that, in their view, grew too large for a market opportunity where their target companies (entrepreneurs) preach capital efficiency. I would not be surprised if they forecast the rates of return in buy-outs and real estate, which have traditionally been the largest component of the Alternative investment basket declining substantially. The prospect of these asset categories experiencing fundamentally declining returns, due to the prohibitive state of the debt markets, and deleveraging causing prices to drop, signal a prudent change in portfolio approach, not a panic.

3. Fund of funds, long a source of capital to the VC market are also experiencing long closing cycles. This will hurt PE and VC fund raising.

4. Today's exit environment is truly hostile. Other than hindering fund raising (a big thing), I am not sure it augers poorly for VC firms where we can 'buy low' and hope to reap returns through participating in equity value building by entrepreneurs building companies that will save their customers time, proffer revenues, or offer good old plain fashioned fun. The exit events for these investments are years off; who knows , we may have a President Bush in the White House when this happens....

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