Inside the Vault: Where do we go from here?

Such sacrifices are unavoidable whenever the economy is in turmoil, regardless of how the University invests its money. But after last year’s market turbulence, the Princeton University Investment Company (PRINCO), headed by its president Andrew Golden, is re-examining its investing strategy with the aim of increasing liquidity.

The most contentious part of PRINCO’s strategy is its reliance on illiquid assets, such as private equity. These sorts of assets are effective means of securing high returns in the long run, but they also limit the University’s ability to raise the short-term cash it needs to fund its operating budget.

In 2008, 25 percent of the University’s endowment was invested in private equity. That percentage has risen slightly since then, Golden said, adding that he would like to see it come back down to a quarter of the endowment. This will be a challenge because the private equity market is fairly small, so PRINCO would need to sell those assets at very low prices to quickly reduce their representation in its portfolio.

That’s something Golden isn’t willing to do. Instead, PRINCO has begun to make smaller commitments to outside funds that invest in private equity, and Golden said he will make small sales of current assets.

Over time, the percent of the endowment in private equity will “glide down,” Golden explained.

A former PRINCO investment manager who spoke on the condition of anonymity said he thought the University needed to make more drastic changes to its investing strategy.

“There should be a halt” to the purchase of private equity assets, the former PRINCO manager said. “I wouldn’t want to see the illiquid portfolio become more than 20-odd percent of the total portfolio.” But he noted that there’s “not much you can do” about reducing private equity assets since they’re illiquid.

And though Golden’s new target for bonds as of October is 6 percent — higher than the 5 percent reported in 2008 — the former PRINCO manager still noted, “That’s awfully low.”

Investing in bonds, which often guarantee a fixed interest rate regardless of the health of the economy, can be one of the best insurance policies against a bad year in the markets. These fixed-income assets are easy to sell, and they may even increase in value when other markets are down. Yet the returns they offer on investment are typically very low.

The former PRINCO manager said he would like to see more of Princeton’s endowment funds allocated in fixed-income assets. But he also noted that this isn’t the best time to invest in bonds since they are currently commanding especially low interest rates.

Even so, international bonds could offer a good opportunity to raise the University’s income and should be “strongly considered,” the former manager said.

“The S&P stock index yields about 2 percent today,” he said. “Bonds are at least better than stocks.”

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The former PRINCO manager added that PRINCO should invest more in commodities like gold and silver, which he said will become increasingly attractive as paper money falls out of the market's favor.

James Clark Jr. ’60, an experienced investor and retired general partner at the investment firm Tweedy, Browne, said that one of the best investment opportunities over the next few years will be in distressed debt — debt that will likely not be repaid in full. Instead, the debtholder can seize the assets of the debtor.

Golden said that PRINCO has already pursued some opportunities involving bankruptcy. He said that Princeton made “significant returns” investing in the claims on Enron after it filed for bankruptcy in December 2001.

And Tad LaFountain III ’72, a former Wall Street analyst and portfolio manager, called for a significant revision of PRINCO’s approach to investing, pressing for an increase in transparency and oversight.

“At a university whose mission it is to promote truth and openness, there’s been no disclosure of the outside managers” PRINCO hires, he said, adding that reporting on the endowment is “miniscule and delayed.” The Treasurer has yet to release its official report on the University’s finances for the year 2007-08, for example.

LaFountain also questioned the credibility of Princeton’s Report on Investments, which is written by the PRINCO president and not by the University Board of Trustees or some other oversight body.

“I can understand why an employee would report to the oversight board,” he said. “But when [the Report on Investments] goes to the broader public, it should be by the oversight board.”

LaFountain added that the past performance of the endowment by no means guarantees that it will continue to perform well in the future, especially since PRINCO’s private equity investments are artificially inflated.

“Andrew Golden can talk all he wants about the spectacular performance in the last 10 years,” he said. “Now it’s the ride down.”

To avoid that potential calamity, LaFountain said, 50 percent of the endowment should, as a matter of policy, be invested in fixed-income assets. He suggested using the other half of the endowment fund to purchase riskier assets that could provide the University with greater returns, he explained.

President Tilghman, however, said that increasing the amount invested in bonds would undoubtedly lead to lower returns. The University, she noted, must be careful about the percentage of funds it puts into fixed-income assets.

“It’s clearly not going to be 50 percent,” she said.

Especially because of the University’s unusually high reliance on the endowment for its operating budget, however, maintaining liquid funds is very important.

Nearly half of the University’s operating budget is funded by the endowment. Harvard and Yale, by comparison, draw from their endowments for about 35 and 44 percent of their operating budgets, respectively.

Tilghman said that because the endowment has been growing at a much faster pace than the operating budget, the percentage of the budget funded by the endowment has slowly crept higher. And if the markets return to pre-crisis levels, that percentage should stay about constant, she added.

LaFountain contended that getting lower returns might be an appropriate price to pay for more financial security and liquidity.

“Is there some sort of manifest destiny that this university should be able to do everything it wants to?” he said. “Part of life is discernment, what you can do, and how you can do it.”

What’s being done

The University has indicated that it will rethink its approach to the liquidity of its endowment funds. Tilghman said the University was considering creating a new pool in the endowment specifically to provide short-term liquidity. This pool would consist of highly liquid assets that “one would not hesitate for a moment to call upon,” allowing the University to quickly access larger sums of money.

Golden said this pool would complement the two existing pools in the endowment: one for working capital, which provides funds to be used the very next day, and the other invested for very long time horizons.

Tilghman said decisions regarding the makeup and size of the new pool would be made within six months.

Given the economic turmoil of the past year, some of these adjustments are bound to happen. But Golden said that, in the discussions he has had in the past few months, PRINCO has asked the same “tough questions” as in previous years.

The fundamental question is, “Do we have the right approach?” Golden explained. That question is asked every year, regardless of the endowment’s performance.

“The lesson to be learned [from this past year] is that doing the right thing over the long term is the right thing,” he said.

“I would emphasize that, when we do our analysis each year, we allow for the fact that we do have experiences like the past year,” he added. “That doesn’t mean it wasn’t painful when it happened.”

This is the final article in a five-part series on the University’s endowment and investment practices.