Nearly a quarter of Yale’s endowment is invested in venture capital.
Tim Tai, staff photographer
Yale’s endowment reaped the benefits of a banner year for venture capital, with US investment in the industry hitting $330 billion for the first time in 2021.
University endowments with large venture capital holdings saw the highest returns in decades as venture capital markets boomed, with endowments at schools such as Washington University in St. Louis and Duke University climbing more than 50%, according to the Wall Street Journal. The Yale Endowment, which posted a 40.2% rate of return last year – its highest rate since 2000 – made its first venture capital investment in 1976 and has since increased the target allocation to the asset class at 23.5%.
“Yale’s venture capital portfolio has grown over time through a combination of strong performance and increased new investment,” Danny Otto, associate director of the Yale Investments Office, wrote in an email to the News. . “We view the opportunity to harness new technologies to create new businesses across all sectors of the economy as a generational opportunity and have invested accordingly.”
In 2020 – the most recent year for which full data is available – 22.6% of Yale’s endowment was invested in venture capital, compared to 7.7% for the average educational institution. In June 2020, the target allocation for venture capital was increased to 23.5%. Other asset classes include absolute return, public equities, leveraged buyouts, and real assets. According to the 2020 Endowment Report, the venture capital portfolio earned an annualized return of 21.3% for the ten years ending June 30, 2020, while the overall endowment recorded annual returns of 10.9% over the same period.
According to Matthew Rhodes-Kropf, managing partner at Tectonic Ventures and visiting associate professor at the Massachusetts Institute of Technology, the huge growth in venture capital can be attributed in part to companies that are rapidly adopting new technologies.
“The market is incredibly hot,” Rhodes-Kropf wrote in an email to The News. “Trading is happening at an incredible speed and valuations are rising. However, it is also becoming so clear how much the world needs to be automated… the size of the opportunities around us are enormous.
But despite their potential, venture capital investments are inherently risky – up to 75% of venture-backed companies fail to generate returns for their investors, according to research by Shikhar Ghosh, senior lecturer at Harvard Business School.
Josh Lerner, professor of investment banking at Harvard University, explained that although venture capitalists can minimize risk by “closely monitoring” entrepreneurs and providing funds in stages based on the success of business, determining which start-ups will succeed is very hard.”
“Since the very early days of the industry, venture capital-backed companies have been funded and generally taken public before they were profitable,” Lerner wrote in an email to the News. “Valuing these companies is therefore difficult using conventional techniques.”
However, university endowments have a venture capital advantage. According to Sarah Reed, general counsel at RA Capital Management, endowment managers can manage risk because of their long-term time horizon and large portfolio.
Also, those who control the endowment can use their connections in venture capital to get better returns. A case study conducted in November 2020 by Lerner regarding the Yale Investments Office showed that the highest returns are generally achieved by the best known and most established venture capital funds. As a result, larger endowments like Yale have an advantage due to their existing ties to top funds.
“Yale’s long-standing relationships in the venture capital world put the university in a different position than a new entrant,” Lerner wrote in the filing.
The gap between major venture capitalists and the rest of the industry has been well documented. A 2012 study by Diane Mulcahy, director of private equity at the Ewing Marion Kauffman Foundation, analyzed the performance of 100 notable venture capital firms over 20 years and found that the majority of venture capital funds do not had not exceeded public market yields. Of the 20 companies that beat public markets by more than 3% a year, half were founded before 1995.
“I think it’s true in the industry that, you know, the rich get richer,” Reed told the News. “But everyone is pretty mediocre.”
Although venture capital funding hit an all-time high in 2021, some investors are increasingly worried about the market overheating, pointing out that startup valuations have risen faster than their revenues.
So far, however, the Yale Investments Office plans to continue investing in venture capital. According to the 2020 Endowment Report, “Over the longer term, Yale seeks to allocate approximately half of the portfolio to the illiquid asset classes of leveraged buyouts, venture capital, real estate, and natural resources.”
“Our investment strategy is based on making bottom-up investment decisions to partner with the best venture capitalists in the world and not trying to time the market,” Otto wrote in an email to the News. “While we don’t have a firm view on whether or not we are in a tech bubble, we anticipate that it will be very difficult to replicate the recent outstanding performance of our venture capital portfolio in the years to come. to come.”
Reed explained that while fears of a venture capital meltdown have gained ground many times in the past, they have never manifested themselves in the market.
“I’ve been working in venture capital firms for 30 years now and I’ve heard this fear often. And when you’re in those times, the so-called bubble times, that’s definitely the case,” Reed said. “Yet the best companies continue to produce good returns…so I don’t see large endowments turning away from these types of investments.”
Yale’s endowment reached $42.3 billion in fiscal year 2021.