Like a grade-schooler plied with cake and ice cream at a piñata party, the UC endowment is bouncing off the walls on a sugar rush these days. The endowment reported double-digit returns for fiscal 2017 after investing in some “unconventional” assets.
Now, UC officials believe there are more such returns to be had by investing ever more money in private-equity funds. Those officials need to calm down.
Prior to fiscal 2017, the endowment – which technically is managed by the 18-member UC Board of Regents – had been unable to match even the average five-year returns of the typical American’s 401(k). But earlier this calendar year, the Regents Investment Subcommittee announced the endowment’s private-equity target would climb from 11.5 percent to 22.5 percent of the system’s entire $10.3 billion endowment.
Besides the claxons that ought to sound when a single asset is slated to double in size and mushroom to nearly a quarter of the entire endowment, there’s a deeper problem.
Private equity firms, once known as “corporate raiders,” have too much cash lying around these days because the businesses and assets they typically buy and turn around for quick profits have become overvalued. Private equity managers are sitting on nearly $1 trillion of uninvested cash, according to Bloomberg, as endowments and pension funds continue to throw money at them.
This uninvested money is known in the industry as “dry powder.” (If middle-aged guys at desks in Manhattan want to wield a term used by pirates and naval gunnery officers, I’m not judging.)
Private-equity activity has slowed while valuations have climbed to a 10-year high, Murray Devine, an advisory firm, recently reported. Even emerging-market debt and junk bonds have become expensive.
“The champagne corks are not popping … many (private-equity firms) are finding they cannot realize profits on boom-era buyouts,” editorialized the Association of Corporate Treasurers.
The Fed will add to the industry’s woes. Almost a decade since it began buying bonds to stabilize the collapsing economy, the Fed signaled it will begin withdrawing some of the trillions it has invested. This, and rate hikes, will close the spigot of easy money private-equity firms have depended on to goose their returns.
As in any sector deluged by other people’s money – see the subprime meltdown a decade ago – the cash tsunami has gotten private-equity managers to engage in all manner of predictable human behavior. The young ones are now leaving big firms to form startups with the aim of corralling some of the cash. Gimmicky maiden funds are being launched faster than glassy-eyed chief investment officers at public institutions can shovel cash into them.
The focus among private-equity managers has shifted from identifying opportunities and unlocking value to courting institutional investment chiefs and shilling new funds. While the uninvested money sits high and dry, the funds – especially the upstarts – are raising management fees, according to a finding by Prequin.
Public employees – especially committees of them – have a track record of being late to the game, catching a wave after it’s broken.
The UC’s newfound private-equity love affair is a prime example. All the while, the cash piles up. To quote the late Illinois Republican Senator Everett Dirksen: “A billion here, a billion there, pretty soon, you’re talking real money.”
“It is feeling very, very frothy,” Rhonda Ryan, a managing director at investment adviser Pavilion Alternatives Group, told the Wall Street Journal in September.
The parked cash might be too big a temptation for young, itchy trigger fingers. The best scenario is that a quarter of the UC endowment sits around being eroded by high fees while the chief investment officer and regents, now locked in, wring their hands.
UC Merced’s endowed funds, like those of other UC campuses, are managed by the regents.
Those funds need a return of 7.4 percent annually to maintain purchasing power in light of spending, inflation and management costs. Ending fiscal 2016, the regents reported UC Merced’s endowment over the previous five fiscal years had earned an average of 6.3 percent a year.
The UC endowment’s rolling five-year average return will climb to 9.4 percent for fiscal 2017, but by comparison, a portfolio invested 60 percent in a U.S. stock index and 40 percent in a bond index would have earned 8.9 percent annually as of the close of 2016.
UC Chief Investment Officer Jagdeep Bachher, one of the highest-paid UC employees, drew a salary in 2016 of $1.3 million. If returns stagnate – or worse – in the coming years, it will be hard to justify Bachher and his staff of 60 when the regents could simply have bought index funds and done better.
Jeremy Bagott is a former journalist who writes about finance, land-use and public policy issues. He wrote this for The Modesto Bee. Email: firstname.lastname@example.org