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Tuesday, October 6, 2009

Stanford Goes For Liquidity...and Others May Have to Mark Down Their Portfolios




Stanford has decided to try to sell off some of its venture capital holdings in an effort to raise cash. As noted in the nyt today, this move could have wide expectations for its fellow university endowments.

First off, the move represents a further retreat from the "Yale model" which incorpates large holdings in alternative investments such as private equity, hedge funds, commodities, and real estate. As I have noted in earlier posts, the financial market's meltdown revealed several unanticipated aspects of the strategy. The alternative assets did not provide the desired diversification relative to conventional asset classes. Additionally, the consequences of the lack of liquidity in these altertaive asset classes meant that the endowments had to either borrow or sell more liquid assets to raise funds for current expenditures. Selling off the liquid assets of course would make the alternative assets an even larger percentage of the portfolio holdings.

Stanford's solution is to sell of parts of its private equity investments to third parties since it cannot liquidate the holdings with the private equity firms. As noted in the nyt article(below), the transactions are likely to be consummated at price levels far below reported values. Harvard reportedly shopped around some of its private equity holdings and balked after receiving bids for 50 cents on the dollar.

The potential sale raises some interesting questions:

1. If Stanford sells of some of its private equtiy holdings at deep discounts to their reported value will it be able to justify valuing its remaining private equity holdings without factoring in a discount to reported value ?

2. Even more evident, as noted in the article, are the consequences for other universities that hold investments in the same private equity firms. If Stanford has established that fair market value for the holdings is way below reported value, how will the other endowments justify not "marking to market" their holdings.

Although college endowments are allowed to value their assets at a hold to the maturity value will the trustees of these schools accept such a methodology. And even more important, should a University doing financial planning use an endowment value they know is way above market values.

Will Universities wind up using "shadow accounting" with internal planning based on an endowment value well below the externally reported value ? And what will the Univesities use in fundraising: a low number in an effort to indicate the importance of raising new monies (thus acknowleding larger than reported investment losses) or a higher number which would make the university look unrealistically financially secure.

Ironically the above issues are quite similar to the ones that arose when the major banks balked at selling off their "toxic assets" through some type of market mechanism. Once a market price is established it is difficult to argue that the whole asset class shouldn't be marked to market. And the dispute between mark to market vs another "fair value" (or mark to myth to the skeptics) as a method for valuation was a key feature of the debate over bank balance sheets.


my bolds my comments in italics

October 6, 2009
Dealbook
Investment Indigestion at Stanford
By ANDREW ROSS SORKIN

Stanford University is holding a garage sale....

During the boom times, Stanford Management, joined other endowments in a rush to plow increasingly large percentages of their funds into private equity, real estate and other illiquid investments — committing some $12.6 billion of the university’s endowment.

But then the market soured, and Stanford’s endowment lost $4.6 billion in value in its last fiscal year, a decline of 27 percent. So it now seems to be suffering from investor’s remorse.

Its plan to sell part of its stakes in private equity firms — a bid to raise $1 billion or more — appears to be an attempt to cut losses on current investments and a way to get out of committing more money to future deals....

Harvard, whose endowment shrank 27.3 percent last year, looked to sell some assets earlier this year. But given the lukewarm response, it struggled in a bid to sell about $1 billion of assets before pulling the sale. The California Public Employees’ Retirement System has been looking to sell, too....

Stanford isn’t planning to sell stakes in individual private equity deals. Rather, it wants to sell its place as an investor in private equity firms. (The funds, of course, won’t just let endowments out of their commitments.)....

.. it’s a rare chance to get a portfolio of this quality and of this size.”

Even so, Stanford’s decision will send a chill through the halls of endowment offices at other universities. By trying to sell such a large position all at once, Stanford will invariably depress prices for any institution considering a similar move....

it did,in fact, already take out an expensive $1 billion line of credit as a cushion in the event that it needed help keeping the lights on for students. Its decision, according to people who have been briefed on the university’s thinking, is a strategic one — it wants to reduce its exposure to future private equity deals.

But taking this step suggests that Stanford wants to distance itself from other endowments like that of Yale, led by David F. Swensen, who pioneered the push toward universities holding illiquid investments.

That strategy is often called the Swensen model. His fund has been decimated as well, falling $5.6 billion, or 24.6 percent, in the last year. (The average large university endowment dropped 17.2 percent in that period, according to the Wilshire Trust Universe Comparison Service.) But unlike Stanford, Mr. Swensen is not changing course and selling assets — at least not yet.

Stanford will be trying to sell to a group with some pretty hardball techniques when clsing deals:

When Stanford tries to sell its stakes in private equity portfolios, it will be entering a netherworld of secondary deals inhabited by a small cadre of investors looking to buy stakes on the cheap. They include AlpInvest Partners, Coller Capital, Credit Suisse, HarbourVest Partners, Goldman Sachs and Lexington Partners. The auction is being handled by Cogent Partners.

Nyppex, which tracks secondary deals, said that earlier this year such deals were made at 29.3 cents on the dollar, based on net asset value.

That number has moved up in recent months as confidence has returned to the markets, and Nyppex’s latest estimation indicates that recent deals have gone for an average of 51.58 percent of net asset value.

One question that has vexed the endowment industry is how to determine the value of portfolios. At the end of every quarter, private equity firms typically send out current valuations of their portfolios and the endowments accept them at face value.

But what happens if Stanford is able to sell its stake at only 50 cents on the dollar, for example, when K.K.R. is listing it at 80 cents? If other endowments hold similar stakes, what happens to their value?

This is still a hypothetical, because unlike investment banks, endowments don’t have to mark to market. Instead, they value their assets on a hold-to-maturity basis, which means they should not have to reduce the value of those portfolios in the short term.

But if things get worse, will they have to?
Universities specialize in the art of big-picture questions. This probably isn’t one they want to contemplate.

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