Venture capital gains drive University’s endowment growth

Nearly a quarter of Yale’s endowment is invested in venture capital.

Alex Ye

12:00 am, Jan 27, 2022

Staff Reporter

Tim Tai, Staff Photographer

Yale’s endowment reaped the benefits of a record-breaking year for venture capital, with U.S. investments in the industry reaching $330 billion for the first time ever in 2021.

University endowments with significant venture holdings saw the highest returns in decades as venture capital markets thrived, with endowments at schools such as Washington University in St. Louis and Duke University climbing more than 50 percent, according to the Wall Street Journal. Yale’s endowment, which saw a 40.2 percent 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 to 23.5 percent. 

“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 novel technologies to build new businesses across all sectors of the economy as a generational one and have been investing accordingly.”

As of 2020 — the most recent year with complete data available — 22.6 percent of Yale’s endowment was invested in venture capital, compared to 7.7 percent for the average educational institution. In June 2020, the target allocation for venture capital was increased to 23.5 percent. 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 percent for the ten years ending June 30, 2020, while the overall endowment had annual returns of 10.9 percent over the same period.

According to Matthew Rhodes-Kropf, a managing partner at Tectonic Ventures and visiting associate professor at the Massachusetts Institute of Technology, the enormous growth in venture capital can be attributed in part to companies adopting new technologies at rapid speed.

“The market is incredibly hot,” Rhodes-Kropf wrote in an email to the News. “Deals are happening incredibly fast and valuations are rising. However, it is also becoming so clear how much of the world needs to be automated … the sizes of the opportunities around us are huge.”

But despite their potential, venture capital investments are risky by nature — as many as 75 percent of venture-backed companies fail to generate a return for their investors, according to research done by Harvard Business School senior lecturer Shikhar Ghosh. 

Josh Lerner, a professor of investment banking at Harvard University, explained that although venture capital investors can minimize risk by “tightly monitoring” the entrepreneurs and providing funds in stages based on the success of the company, figuring out which start-ups will be successful is “very hard.”

“Since the very first days of the industry, VC-backed companies have been financed and usually gone public before they were profitable,” Lerner wrote in an email to the News. “Valuing these businesses is thus challenging using conventional techniques.” 

However, university endowments have an advantage when it comes to venture capital. According to Sarah Reed, general counsel at RA Capital Management, endowment managers can handle the risk due to their long-term time horizon and large portfolio. 

Furthermore, those controlling endowment can utilize their relationships in venture capital to achieve better returns. A Nov. 2020 case study by Lerner concerning the Yale Investments Office showed that the highest returns are usually achieved by the most well-known and established venture capital funds. As a result, larger endowments like Yale have an advantage due to their existing connections to the best funds.

“Yale’s long-standing relationships in the venture world put the university in a position different from that of a new entrant,” Lerner wrote in the case.

The gap between the top venture capital firms and the rest of the industry has been well documented. A 2012 study led 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 had failed to exceed public market returns. Of the 20 firms that had beat the public markets by more than 3 percent annually, half of them were founded prior to 1995.

“I think it’s true in the industry that, you know, the rich get richer,” Reed told the News. “But everybody else is pretty mediocre.”

Although venture funding hit an all-time high in 2021, some investors are becoming increasingly concerned about the market overheating, pointing out that startup valuations have grown 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 one-half of the portfolio to the illiquid asset classes of leveraged buyouts, venture capital, real estate and natural resources.”

“Our investment strategy is predicated on making bottom up investment decisions to partner with the best venture investors in the world and not trying to time the market,” Otto wrote in an email to the News. “While we don’t have a strong view as to whether or not we are in a technology bubble, we expect that it will be very difficult to replicate our venture portfolio’s recent outstanding performance in the coming years.”

Reed explained that while concerns of a venture capital collapse have gained traction 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 that fear many times. And when you’re in those times, the so-called bubble periods, it certainly feels that way,” Reed said. “Yet the top firms continue to produce good returns … so I don’t see the large endowments turning away from those types of investments.”

Yale’s endowment reached $42.3 billion during the 2021 fiscal year.