Amay Tewari, Senior Photographer

The University seems to have preserved its capital in a year marked by volatility and shrinking college endowments. But experts say that the way certain assets are priced may mean Yale’s true returns are lower than reported. 

Their analysis hinges on the pricing of illiquid assets — assets that cannot be quickly converted to cash, such as real estate, private equity and venture capital. These assets, which have no concrete market value until they are sold, must be priced when reporting returns, and during downturns could be estimated more favorably to aid otherwise poor numbers.

“It’s hard to know for sure what these investments are worth at any point in time, and any endowment that invests heavily in illiquid assets is really just producing estimates of the portfolio’s fair market value each year,” NYU Stern professor David Yermack wrote to the News.  

Alternative investments refer broadly to non-traditional assets, which are often illiquid. These assets were particularly difficult to value in 2022, Yermack wrote, because a slow economy translated to fewer transactions and less data on which to base an estimation. 

Yale School of Management professor James Choi and institutional fund expert Charles Skorina also described illiquid assets as a point of difficulty in estimating returns. Overall, their analysis suggests that Yale’s true endowment return could be lower than the 0.8-percent gain the University posted last week. 

Yale’s numbers this year have nevertheless outperformed those released by peer institutions, which Skorina said is relevant because other university endowments are similarly vulnerable to pricing imprecision. So far, Cornell University, the University of Pennsylvania, Dartmouth College and Duke University have all reported negative or near-zero endowment returns. 

As of 2019, about 60 percent of Yale’s portfolio was allocated to alternative investments, implying that reported returns depend in large part on estimated values. 

For over 35 years, David Swensen managed the Yale endowment under “The Yale Model,” a framework for institutional investing that he developed alongside then-senior endowment director Dean Takahashi. 

The Yale Model favors broad diversification of assets, allocating less to traditional U.S. equities and bonds and more to alternative investments like private equity, venture capital, hedge funds and real estate. Swensen passed away last year, but the Yale Model has remained the University’s primary investing scheme — and has become the industry standard over the last three decades.

A revolutionary premise of the Yale Model is that liquidity — the ability to quickly buy or sell an asset without drastically changing its price — can be undesirable. The bulk of Yale’s investments are illiquid, and thus difficult to evaluate. Until these assets are sold, their prices can only be estimated, often using a combination of complex market analysis, mathematical modeling and subjective reasoning. 

But the Yale Model’s strong preference for alternative investments makes the University’s endowment numbers much more susceptible to estimation-based imprecision.

That imprecision could “[apply] more to Yale than any other university, given its very large over-weighting of so-called alternative investments,” Yermack wrote.

Imprecision itself can also be difficult to pinpoint because of the Investments Office’s reliance on third-party managers.

Instead of carrying out in-house investing for specialized assets, the Office generally delegates to external investment managers, allowing Yale to diversify its investments more than it could otherwise.

Heavy reliance on investment managers has made manager selection at Yale a famously deliberate process. According to the Yale Investments Office website, Yale’s “superior manager selection” contributed 2.4 percent per annum of outperformance relative to the median university endowment.

While these third-party managers can boost returns, they can also make accurate asset valuations more difficult.

“The smartest people on earth can’t figure out what these assets are worth until they sell them,” Skorina said. “If a private equity firm tells Yale an asset is worth some amount, how do they really know that?”

The Yale Investments Office confirmed that it “generally uses valuations provided by its investment managers.”

Per the Investments Office, “the majority” of these managers report their investments at fair market value in compliance with Accounting Standards Codification 820. 

“Determination of fair value relies upon several accepted valuation methodologies: third-party appraisals, similar transactions, marketable comparables, option pricing models and discounted cash flow models,” an Investments Office spokesperson wrote in an email to the News. 

The spokesperson said that the Office believes its valuation procedures are currently applied in a manner consistent with “standard industry practice” and Generally Accepted Accounting Principles, or GAAP, which are guidelines imposed by the U.S. Securities and Exchange Commission.

Skorina told the News that even with these measures, there is “wiggle room,” particularly in the pricing of private equity and venture capital investments.

“Swensen was terrific,” Skorina said. “There is beauty in alternative assets; everyone has a vested interest in showing wonderful gains and minimizing losses. But, until an asset is sold, there’s a lot of flexibility around what you can say it’s worth.”

Other experts, including Rutgers Business School professor John Longo and School of Management professor William English, wrote to the News that Yale’s performance was good considering the market circumstances.

According to Choi, though, this does not imply that Yale’s published returns are totally reliable.

“That return looks pretty good, considering that an investment in the S&P 500 that reinvested dividends back into the index lost 11 percent over the same period,” Choi wrote in an email to the News. “The caveat is …  there’s evidence that private equity managers smooth out reported returns over time, rather than recognizing the full impact of market losses and gains immediately. That sort of smoothing would temporarily make endowment losses look less severe.”

Skorina explained that such smoothing can happen any year, but, when the market is doing worse, the problem is often more pronounced because “there is a greater incentive to cheat.” 

This year, Yale’s returns were their lowest since the Great Recession, when the endowment tanked nearly 25 percent.

After large university endowments dropped record levels in 2009, a 68-page report released in May 2010 by the Tellus Institute concluded that “the endowment model of investing is broken. Whatever long-term gains it may have produced for colleges and universities in the past must now be weighed more fully against its costs — to campuses, to communities and to the wider financial system that has come under such severe stress.”

In response to the report, Mark Yusko, a veteran endowment manager and the founder of Morgan Creek Capital Management, argued in a video interview that the endowment model — a more general name for Swensen’s Yale Model — remains the most viable proposition for long-term investors. 

However, he commented that pricing obscurities can have an outsized impact on reported performance now that large endowments depend so heavily on alternative investments.

“You can’t fault the endowments, but they’re just as aware of the issue as everyone else,” Skorina said.

The S&P 500, short for “Standard & Poor’s 500,” was introduced in 1957 to track the value of 500 large corporations on the New York Stock Exchange.

Evan Gorelick is Managing Editor of the Yale Daily News. He previously covered Woodbridge Hall, with a focus on the University's finances, budget and endowment. He also laid out the weekly print edition of the News as a Production and Design Editor. Originally from Woodbridge, Connecticut, he is a junior in Timothy Dwight College double-majoring in English and economics.