Endowments tap alumni for PE opportunities, but does it pay off?

Last weekend, on my usual jog through Central Park, every iconic mile marker— Shakespeare Garden, Bethesda Fountain, Bow Bridge—was engulfed in violet.

NYU's graduation day had sent hoards of students in satin gowns and mortar board caps to every corner of the park, sweaty photographers in tow.

More than a third of NYU's MBA graduates go into financial services. For colleges and universities, this stream of alumni offers a point of connection to tomorrow's decision (and money) makers. Many endowments, eager to employ this competitive advantage, tap into that sea of violet when deciding where to invest.

That's certainly the case in private equity, where the alumni network offers endowments favorable fees, greater transparency into fund mechanisms, and access to stronger deal sourcing. But the network's benefits don't always show up in the institutions' annual returns.

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At Anthony Scaramucci's SALT conference in New York City, Joe Dowling, global head of Blackstone Alternative Asset Management and former CEO and CIO of Brown University's Endowment, shared how the investment office at the endowment tapped into its alumni network for private market investment opportunities. This strategy, Dowling said, gave Brown a leg up on its returns.

In 2018, Dowling's final year as CIO before assuming the CEO position, the endowment generated an annualized return of 13.2%. This was an impressive return for this year. For reference, Harvard University's endowment—the largest university endowment, and one often used as a benchmark for other schools' investment performance—returned 10% in fiscal year 2018 with a 16% allocation to PE. Yale University, under the late David Swensen's notoriously alternative-heavy thesis known as the "Yale Model," returned 12.3%.

Swensen was also known for his position in Yale's exclusive alumni network, which he reportedly leveraged to source deals in the early days of alternatives.

Despite Brown's slight (but nonetheless notable) outperformance of the country's two largest endowments, research shows that alumni ties aren't associated with better overall returns. In a  recent paper, academics from the University of St. Gallen did not find any evidence of outperformance among endowments that invested with alumni-managed PE funds compared to peers that did not.

Still, the research showed that university endowments in the US are more likely to put capital into vehicles that are managed by the alumni of the university. This begs the question: What's the point of investing with alumni if it's not propping up overall returns?

According to the authors, this tendency is likely due to the core plights of the institutional investor: opportunity sourcing and private market opacity.

1. Sourcing is instrumental to investors. In a BlackRock survey of over 200 institutions, including public and corporate pensions, endowments and foundations, family offices, and sovereign wealth funds, the majority of respondents said their top priority in selecting a private market manager was that manager's access to opportunities—above the manager's investment strategy, expertise across asset classes, and ESG approach.
   
   The PE industry has quintupled in size over the past two decades, according to PitchBook's Q1 2023 US PE Breakdown. With so many options, the manager selection process is highly detailed and complex for LPs. Alumni networks work as a "channel of access" for LPs looking for the best opportunities in a competitive investing environment, the paper said.  

2. In a 2022 Schroders survey of 770 institutional investors, respondents said their main challenge in investing in private assets—other than astronomical fees—was the market's lack of transparency and access to consistent data and information.
   
   Alumni connections to the private equity industry can help alleviate some of the opacity LPs experience in their exposure to the asset class. Theoretically, if an LP has a connection to a GP beyond the simple transaction, the GP could be inclined to provide them with greater insight into the inner workings of the fund.
   

3. Another benefit that doesn't explicitly show up in an endowment's fiscal year performance report is the ability to negotiate better terms within a cozier LP-GP relationship.
   
   "My understanding of David Swensen's success with alumni is the very favorable terms he was able to negotiate for Yale when seeding alumni. So it's not clear to me, absent a fund-by-fund review, that Yale generated better returns because the alumni were better investors—or if they were average investors, but the low fees resulted in better than average returns," said Michael Rosen, CIO at Angeles Investments, an outsourced CIO for foundations, endowments and other nonprofits. "Of course, it could be both, but I think this aspect of very favorable terms is often overlooked."
   
   This importance of social ties isn't exclusive to the Ivy League. The authors also found that endowments were most inclined to tap into alumni networks at universities with lower rankings and less experienced endowment investment offices.
   
   Overall, an alumni network presence in PE grants endowments a certain level of access into these funds that they aren't guaranteed in the absence of a shared alma mater.

I finished my jog near the Plaza Hotel, narrowly dodging another plum-enshrined 22-year-old on my final sprint. I thought about these graduates and how they would soon trade their polyester gowns for pleated suits; start an internship; launch into an entry-level consulting gig; or land a dream job at a PE firm, all the while carrying their school's name with them as they climb.

Featured image by Chloe Ladwig/PitchBook News

This article originally appeared on PitchBook News