Yale Pays for Access

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Yale recently defended its payment of high investment fees at time when other larger investors are using low cost, passive equity strategies. While Yale’s use of illiquid assets is partly the reason for the high fees, the debate really illustrates the rise of the private over public equity markets.

Despite having $26 billion in assets, Yale said in its latest annual report that it could not negotiate lower fees because…

“Venture capital and leveraged buyouts present the greatest challenge, as the overwhelming demand for high-quality managers reduces the ability of limited partners to influence deal terms”

Said another way, the demand for talent (managers) exceeds the supply of money (investors). Some have argued the demand for venture capital and leverage buyout investments is driven by performance which has surpassed that of hedge funds since the 2007-2008 financial crisis.

Andrew Lo of MIT said:

“Fee negotiations really depend on the leverage that the parties have. Hedge fund managers have not been producing tremendously attractive returns, they are not going to have much leverage to negotiate better fees….

On the other hand, very successful venture capital companies and private equity companies have produced very attractive returns, and will have much more negotiating power.”

The demise of hedge funds signals the decline of public equity markets. With the rise of information, technology, and hedge funds, public equity markets have become so liquid that there is little chance for most to outperform the market.

Kenneth Griffin of Citadel reflected this week on the state of the hedge fund industry…

“It’s harder to create alpha today, there’s more competition, there’s a lot of very sharp people trying to find opportunities in the market place. This is causing some of the second-tier players to fall by the wayside.”

Unlike public markets, it is difficult for most to access the illiquid, private markets. Rather than paying for performance, Yale could be paying high fees simply to access the deal flow of venture capital and leverage-buyout firms.