Tuesday, January 8, 2013

Making Your Ivy League Degree Pay Off for You and Your University

Making Your Ivy League Degree Pay Off for You and Your University

Graduates of elite universities dominate the investment committees of the their endowments.  No surprise.  Most of the members are drawn from the investment management business.  Again, no surprise.  Who knows more about money management than money managers?  Who do think they tend to hire?  At Dartmouth, trustees or members of the investment committee manage 13.5% of the endowment according to an article in today’s New York Times (“Dartmouth Controversy Reflects Quandary for Endowments”)[1].  The article offers a debate about whether endowments should allow their trustees or investment committee members to manage money.

The two sides of the debate are straightforward.  Dartmouth argues that it would hurt the endowment if they couldn’t access money managers who are also affiliated with the trustees or investment committee.  They cite their one-year and ten-year investment performance, which is significantly better than that of other endowments.  Critics argue that affiliated money managers should not be hired because it is a blatant conflict of interest.  Since the university also has an interest in cultivating the money manager as a donor, they can’t possibly be objective in evaluating the manager’s investing prowess.
Pipeline (2002)

Frankly the debate is ridiculous.  What Dartmouth and other institutions have built is a highly successful business model that is predicated on exploiting conflicts of interest.  They’d be crazy to change the system.  A few months ago, I looked at the composition of the investment committees at Harvard, Princeton, Cornell, Dartmouth, and Duke.  At the time, I was trying to trace the interconnections between university endowments, money managers, and politics by looking at the campaign contributions of members of the investment committees.  What I discovered was a beautifully constructed web of relationships, wherein a relatively small number of money managers have great influence in both the endowment and public sectors. 

Since these institutions aren’t public, there isn’t much transparency, but based on my experience, here’s how the system works.  Let me be clear, as a proud graduate of the State University of New York at Binghamton I was never able to try this out on my own. 

Step 1.  You graduate from with an AB from Dartmouth and go to work at Goldman Sachs for a few years, and then attend Harvard Business School (or the Amos Tuck School of Business at Dartmouth).  You land a job back at Goldman or Morgan Stanley.  You are solicited and begin making modest contributions to your alma mater as you rise through the ranks.

Step 2.  You decide to launch a private equity, real estate, or private equity fund.  As you begin to raise the money, you and your handful of partners consult with members of the investment committee at your respective universities.  You arrange dinner at a fine restaurant or drinks at the university club.  (Dartmouth shares the Yale Club’s facility conveniently located on Vanderbilt Avenue across from Grand Central Station.  It’s easy to have a drink before taking the train home to Darien).

Step 3:  You and your partners get modest commitments from your respective institutions ($10 million).  This gives you huge credibility with high net worth and other investors.  Congratulations you’ve raised your first fund.

Step 4:  With a few hundred million under management, the university knows you have the potential to become a huge benefactor: the kind of donor that has his name on a building.  So you’re invited to become a trustee, or a member of the board of visitors.  In due course, you’ll wind up on the investment committee.  When it comes time to raise your second fund, you will conveniently recuse yourself from voting, but your fellow money managers will wholeheartedly commit $25 million to your second fund.  You’ll do them the same favor.

Step 4a:  By this time, the Republican and Democratic campaign committees and PACs identified you as a source of funds.  As a result, you’ve been invited to all sorts of events on the Upper East Side of Manhattan.

Step 5:  You’ve now got enough of a track record, albeit much of it unrealized gains or small-scale investments, to hunt for elephants.  In the money management business, public funds are the elephants.  With your Ivy League investors as proof of concept, and your political contributions as lubricant, you’re in a position to build a multi-billion fund. 

Step 6:  With a billion or more under management, you are in a position to put an addition onto the business school by making a $50 million contribution to your alma mater. 

Even if your investment performance was mediocre, the university’s return is excellent.  In exchange for paying a 2% fee (plus potential carry) on $10 million and $25 million investments in your first two funds, they eventually receive the big contribution.  By my back of the envelope (actually small spreadsheet) calculation, the university’s IRR is probably north of 75% after cultivating the relationship for seven years.  And, I am not including any of the smaller annual gifts.  If your fund earns carried interest (15% or 20% profit sharing), the charitable contribution could be mammoth: I’m thinking basketball arena.

As far as the elite university endowments are concerned, the sooner the New York Times article becomes old news the better.  They need to get back to business as usual. 

[1] http://dealbook.nytimes.com/2013/01/07/dartmouth-controversy-reflects-quandary-for-endowments/

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