12-7-09: Princeton: Inside the Vault: The Boom Years

A lot of things have changed at Princeton this past year. The construction on Butler College, which began in 2007, replaced brick walls and waffle ceilings with an amphitheatre, a late-night cafe and a myriad of LCD TV-adorned student lounges. The renovations to the Wu and Wilcox dining halls that started last year have seen two aging serveries become a colorful amalgamation of blue, yellow and red plates and some of the best food on campus. Two new buildings on the Street have opened, Campus Club and the Fields Center, both under the University’s aegis.

But look closer and all may not be so rosy.

As part of cost-cutting measures that were implemented last year, meals have not been served at Forbes College on Saturdays this semester. Next semester, there won’t be Saturday meals at Whitman College. Cafe Vivian, once the late-night haunt of students finishing papers to a soundtrack of mellow jazz music, has seen its hours cut during the week, and it is no longer open Saturdays.

Hiring is frozen: The faculty will not grow at all this year. Plans for the University’s arts neighborhood have been put on hold indefinitely, as have plans for new psychology and neuroscience buildings. The University has slashed $170 million from its operating budget over the next two years.

And it pulled $1 billion from its $3.9 billion capital plan for the next 10 years, President Tilghman said in an interview with The Daily Princetonian.

Many of these cuts came in response to the plunge in the financial markets last year, which brought the value of the endowment down by nearly a quarter, to $12.6 billion. But Andrew Golden, the gray-haired and bespectacled president of the Princeton University Investment Company (PRINCO), is not too worried.

“The secret to our success involves being willing to have an embarrassing year like we just had,” he said. “If you’re not willing to lose that much money, you can’t make as much money as we’ve made over the past decade.”

The Yale model

Golden joined PRINCO in 1995, when the value of the endowment was roughly $3 billion. Under his stewardship, it reached a peak of $16.3 billion in 2008. That makes for an average annual return of 14.1 percent, much more than 10 percent annual return on the S&P 500 over that same period. Yale’s endowment, which grew the fastest out of Ivy League endowments during that period, averaged a 17.1 percent annual return.

That difference is part of the reason Yale leapfrogged Princeton to become the second-richest university in the world. (In 1986, Princeton was $200 million richer than Yale.)

But Golden’s approach to investing comes largely from the training he got at Yale. A 1989 graduate of the Yale School of Management, Golden spent five years working at Yale’s investments office under Chief Investment Officer David Swensen, whose revolutionary approach to endowment investing has earned him legendary status among investors worldwide.

Swensen’s influence is broad: Both Golden and Jane Mendillo, who is in charge of Harvard’s endowment, worked under him at Yale.

“He has very clear thinking, which allows him also to communicate very clearly, which was certainly confidence-inspiring at the board level,” Golden told The Yale Herald in 2008. “He just set a tone that assured people that our decisions were going to be made on quality of analysis.”

Before Swensen, most university endowments were invested in bonds, financial assets that generally provide small returns but have none of the risks or uncertainty associated with the stock market. Accordingly, most endowments were fairly small: Yale’s was just $1.3 billion when Swensen arrived in 1986, Princeton’s was $1.5 billion at the time, and Harvard’s was $2.7 billion.

With Swensen at the helm, Yale began to pursue an investment strategy that has come to be called “the Yale model.” Previously, many universities had tried to ensure that most of their funds were invested in highly liquid assets, which can be sold easily at any time for cash. This approach meant that the universities could quickly come up with lots of cash to use should the need arise. Swensen’s maverick idea was that this sort of liquidity should be avoided, since the additional flexibility of liquid assets comes at the cost of much higher potential returns.

Because universities have an extremely long-term investing horizon — no one expects a university to disappear overnight — their endowments can be directed toward getting long-term returns. Unlike most companies, which generally need to be able to summon the cash to pay back investors who want to remove their funds at any point, endowment managers do not have to worry that the university will ask for the entire value of the endowment all at once.

“You don’t have to play the flavor-of-the-month game,” said James Clark Jr. ’60, an experienced investor and retired general partner at the financial firm Tweedy, Browne, who said he was paraphrasing Warren Buffett. “It allows you to be greedy when others are fearful and … to be fearful when others are greedy.”

Endowments can tolerate much higher levels of illiquidity. Because these illiquid assets often get higher returns, Swensen thought it made sense to invest in them more heavily.

Swensen especially wanted to explore private equity, where an investor can take a stake in a small company that is not traded on the market. As that company gets bigger, the value of the stake can grow dramatically, and if the company eventually begins to offer shares on the market, then the university can potentially cash in for a large profit. But it is very difficult to resell stakes in a company like this before it goes public, so the money put into it is more or less locked up for an extended period of time.

For example, highly liquid assets like stocks, bonds and cash made up over 75 percent of Yale’s portfolio in 1986. Now, that percentage has fallen to around 25 to make way for more illiquid assets and private equity, which have risen to 20.2 percent of Yale’s endowment.

The Golden approach

Golden brought this attitude with him to Princeton.

“I’ve stolen 85 to 90 percent of my good ideas from Yale, plus some undisclosed amount of my bad ideas,” Golden told the Yale Daily News in 2005.

Though he said it is not useful to describe Princeton’s endowment as following the Yale model, the percent of the endowment invested in private equity has gone up dramatically since he took charge. The percentage of funds invested in private equity nearly doubled from 15 percent in 2005 to just over 25 percent in 2009.

Nearly 50 percent of the University’s endowment is invested in illiquid assets. This figure includes property the University owns, such as buildings like Nassau Hall, which cannot realistically be sold.

And like Yale’s investments office, PRINCO is more of a “manager of managers.” It does not invest funds directly; rather, it determines how much of the endowment it wants to invest in different asset types, and it seeks out investment managers who will invest the University’s funds in a way that matches up with its goals.

Under Golden’s tenure, the University’s endowment saw the same sort of growth that Swensen brought to Yale’s. At $3.88 billion when Golden took charge, the endowment grew by $13 billion through June 2008.

And until last year, illiquidity wasn’t a problem. Tilghman noted that the endowment has grown much faster than the University’s operating budget — so much so, in fact, that the University now relies on the endowment for 48 percent of its $1.2 billion annual budget.

But in 2008, the global financial crisis threw a wrench in the gears. The endowment’s value fell by 22.7 percent, though it did not fall by as much as Harvard’s, Yale’s or Stanford’s, the only endowments larger than Princeton’s before the crisis hit.

Rather than take money out of the endowment to fund the operating budget for fiscal year 2009, the University chose to issue $1 billion in bonds. This marked the first time that it has had to borrow money for operating costs in 15 years. And along with the bond issuance came the slew of cuts the University instituted this year: closing dining halls for certain meals, instituting a hiring freeze and indefinitely postponing construction projects.

This has led many to seriously question the wisdom of Golden’s approach to the endowment.

This is the first article in a five-part series on the University’s endowment and investment practices. In tomorrow’s paper, senior writer Chetan Narain looks at PRINCO’s long-term approach to investing and its critics.

http://www.dailyprincetonian.com/2009/12/07/24658/