It’s a tough question:
“Every month, David Swensen has to write a check for $100 million to the University,” Deputy Provost Charles Long said, referring to Yale’s chief investments officer. “Imagine you’re Swensen. What’re you going to sell?”
As turmoil in the financial markets continues, the University’s Investments Office still has to fulfill its obligation to transfer funds from the endowment to the University’s operating budget on a regular basis. Doing so means maintaining a steady flow of cash, which sometimes involves borrowing. As a precaution to make sure liquidity remains available, the Yale Corporation in February doubled the amount of debt Yale is allowed to issue to $2 billion, although administrators said they have not yet had to meet that limit and hope not to.
The endowment’s contribution to the operating budget amounted to $1.164 billion, or about 42 percent of the University’s income, in the current fiscal year; it will fall to $1.105 billion, or 40 percent of projected revenues next year. That payout is distributed over the course of the year in installments of roughly $100 million a month. The installments can fluctuate depending on contributions from other sources of income — such as tuition, grants and medical services — and the needs of the operating budget.
But the endowment is not like an ATM, as Vice President for Finance and Business Operations Shauna King told staff in a recent meeting. As a matter of policy, the Investments Office aims to have no cash holdings. And about half of Yale’s portfolio consists of illiquid assets such as private equity and real assets, which are hard to sell quickly.
Turning Yale’s investments into cash therefore requires some kind of “cash event” — landing a gift, receiving a dividend, selling an asset or taking on debt.
“At a time when we’re not getting constant distributions from our private managers, we either have to sell liquid stocks or bonds or use other sources of liquidity in the short run to recover,” University President Richard Levin said in a recent interview.
Fortunately for Yale, the portfolio has many such cash events built in to it. For example, interest payments, dividends, oil extraction and timber harvests all generate cash flow.
Actively managing the endowment’s equity holdings also generates liquidity: Every time a stock is sold, that transaction results in cash on hand.
“In a certain sense, even in better times, you have to sell things to rebalance,” Levin said. “We’ve always gotten turnover.”
So far, Yale has not had to resort to more disruptive methods of generating cash, such as dumping assets on secondary markets at huge losses, as universities such as Harvard have done.
The question of liquidity is a curious one for Swensen, who earned his reputation — and pioneered the model of investing that bears Yale’s name — by emphasizing diversification over liquidity and venturing into illiquid assets.
“Accepting illiquidity pays outsize dividends to the patient long-term investor,” he wrote in his book, “Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment.” (Swensen declined to comment for this article.)
But critics say that approach has now backfired for Swensen’s many imitators, who are finding themselves tied up in illiquid assets and short on cash.
Although the Investments Office planned ahead to manage liquidity, it has sometimes had to borrow — either to provide funds for the operating budget or to obtain money to buy assets.
“We have used some borrowing to meet liquidity needs over the last year and a half,” Levin said, adding that, at the moment, the University is not borrowing to stay liquid. “We did increase the debt authorization in February, but we haven’t used it.”
Yale uses debt mostly for capital spending. The difficulties of borrowing money were a key factor in the University’s February decision to freeze almost all campus construction. But some construction projects, such as the renovations of Morse and Ezra Stiles colleges, are still moving ahead.
Even taking into account Yale’s doubled debt authorization, Standard & Poor’s reaffirmed Yale’s top credit rating in a February report, as did Moody’s in January. S&P was assured by Yale’s large endowment and historically strong financial performance, but the rating agency noted that increases in debt could strain liquidity.
Administrators said the Corporation’s authorization was made to provide a safety net, even though there is no immediate need to issue more debt, according to both interviews and the S&P report.
The last time the Yale Corporation raised the debt authorization was in April 2007, when it was increased to $1 billion.
Total outstanding debt as of June 30, 2008, was $2.98 billion. With the issuance of $2 billion in medium-term notes, the S&P report said the University could owe up to $4.2 billion in total debt.