March 7, 2001: Features

Feeding the Tiger
Princeton's endowment investments return big rewards

By Allan Demaree

Princeton's endowment is a wonder to behold. It has grown to the point that the university's trustees decided in January to increase spending from it by $57 million, or 27 percent, next year. This extraordinary leap, which will finance initiatives ranging from freshman writing seminars to the new "debt-free" student-aid policy, is by far the biggest spending increase in Princeton's history.

Starting with £185 pledged by 10 men in 1745 - not enough to pay the president's salary, as it turned out - the endowment has swelled to $8.4 billion. That's the largest in the nation for a school Princeton's size and third largest among all private U.S. universities (after Harvard and Yale). The endowment contributes more to Princeton's operating budget than any other source, including tuition and fees, sponsored research, and gifts and grants such as Annual Giving. Little wonder that President Harold Shapiro calls the endowment "the critical component in determining what's possible for us here at Princeton to aspire to." Which raises the question, how has the endowment been performing?

The answer is a bit like Henny Youngman's reply to the question, "How's your wife?": "Compared to what?"

By one measure, the endowment has been doing superbly. To support future generations of students as well as it has supported generations past, its growth has to keep pace with the rising cost of providing higher education. Over the past decade, educational costs have risen some 45 percent. During the same period, the endowment grew five times that fast.

By another measure, the news is somewhat less rosy. Fifteen years ago, Princeton's endowment ranked second among private universities, leading third-place Yale by more than $200 million. Now Yale is ahead by $1.7 billion. Top-ranked Harvard has stretched its lead over Princeton from $1.2 billion in 1985 to $10.7 billion today (see chart, page 20).

Three major factors determine an endowment's growth:

1) how much it receives in gifts, 2) how much it contributes to university spending, and 3) how successfully its assets are invested. This article looks at Princeton's investment performance. For the influence of other factors, see "Playing the numbers" on page 20.

Princeton's investment engine has been running on jet fuel lately. Last fiscal year (ended June 30, 2000) the endowment earned 35.5 percent versus 7.2 percent for the Standard & Poor's 500 Index. That was the best one-year performance since 1983 - and poured some $2 billion into Princeton's till.

Over the longer term, Princeton's compound annual return came to 17.1 percent for the 1990s, earning the university more than $7.5 billion. While comparable numbers for all university endowments have yet to be compiled, these results will almost certainly rank Princeton's performance in the top 10 percent for the decade. Princeton outperformed Harvard, which had a 17 percent return, and underperformed Yale, which had a 17.5 percent return.

A company called Princo (for Princeton University Investment Company) oversees the investments. Headed since 1995 by Andrew Golden, 41, a curly-haired elf who once managed money for Duke and Yale, Princo's 10 professionals operate out of a Georgian brick building on Chambers Street, a short walk from Nassau Hall. Princo is "a manager of managers." That is, it farms out chunks of the endowment - $50 million here, $100 million there - to some 100 firms that pick specific stocks, bonds, or other investments in areas of their expertise.

Overall policy is set by Princo's 12-member board of directors, which reports to the university's trustees. The board is made up of three university officials, including President Shapiro, and nine alumni with extensive investment experience. Their major decisions involve how much risk to take, considering that greater risks should ultimately yield greater rewards, and how to allocate assets among major investment categories (such as real estate, venture capital, and international equities).

Endowments as rich as Princeton's have advantages over individual investors. Because they exist for perpetuity, they can take the long view, and because their pockets are deep, they don't have to sell out at the worst time, when fear stalks the markets and prices collapse.

This allows them to be contrarian, buying assets that are out of favor and holding until they pay off. Golden says, "My job is to 'optimize discomfort' - push us to the limit of doing things that are uncomfortable, because that's the way you make money, but not so far that we later become so uncomfortable we abandon the plan we started with."

The plan Princo has been operating under was fashioned largely by Richard B. Fisher '57, former head of investment bank Morgan Stanley & Co., who became Princo's chairman in 1990. Before that, Princo had been a "plain vanilla" investor, mainly holding publicly traded stocks and bonds. Fisher and his colleagues on the Princo board greatly increased Princeton's holdings of more exotic investments - hedge funds, emerging-markets securities, and "alternative assets," which include real estate, venture capital, and other relatively risky private-equity investments. Compared with Harvard, Yale, Stanford, and Duke, Princeton was late getting into these investments and was eager to catch up.

To jump-start the alternative-assets operation, Fisher and his colleagues created a new vehicle called Nassau Capital. Formed in 1995 by Randall A. Hack '69 and three partners, Nassau Capital invested in alternative assets on behalf of Princeton and the partners themselves, increasing Princeton's stake in these assets to more than one-quarter of the entire portfolio. Altogether, Nassau Capital invested $2.5 billion of Princeton's money, having a huge impact on the endowment's performance (see "Adieu, Nassau Capital," page 22).

For a time, some of Princo's bets looked highly questionable. Fisher and his colleagues diversified away from major U.S. stocks, partly because they figured that, after burning up the track in the 1980s and early 1990s, these equities were due to cool off. At one point, Princo used "swaps" and futures contracts to shift nearly one-eighth of the endowment from domestic to international exposure. That left the university underinvested in U.S. stocks just as the market galloped off on a thundering bull run.

Princeton's returns in 1997 and 1998 were respectably in the high teens but lagged behind what a more traditional portfolio - invested 65 percent in U.S. stocks and 35 percent in U.S. bonds - would have achieved. Using this comparison, Princo's 1997 report to the trustees forthrightly judged Princeton's returns to be "very weak." The following year's report, using the same yardstick, declared Princeton's results "poor."

Today, some of the alumni who participated in Princo's decisions concede that the board guessed wrong. John Bogle '51, founder of the Vanguard mutual fund group, says, "The bets were bad. . . . The heavy bet on international, especially on emerging markets, was just plain wrong, and badly wrong." Fisher says, "We were wrong on our assessment of what the U.S. market was going to do."

Having been involved with Princeton's finances for 21 years and having headed Princo for eight, Fisher passed the torch in July 1998 to Edward E. Matthews '53, vice chairman of American International Group, a huge insurance company with over $300 billion in assets. Matthews had served with Fisher on the Princo board for years, and like Fisher was a formidable force in the financial world; he was, for example, the prime mover behind AIG's entering the aircraft-leasing and financial-derivatives businesses, which together now earn the company $1.3 billion a year.

No sooner had Matthews taken over than the international investments took a turn for the worse. Asian markets were already roiling from economic troubles when, in August, Russia devalued the ruble and defaulted on its international debts. Investors fled emerging-market securities, of which Princeton had a passel, and a selling panic spread to Europe.

"I came in," Matthews recalls, "and in the next two months the endowment lost 9 percent of its value. That was not a happy report I made to the Board of Trustees in September. When things like that happen, you begin to question yourself: 'Do I have this thing right?' "

But like Fisher before him, Matthews was not about to crumble in the face of short-term adversity. When emerging-market stocks got pummeled, he and the other Princo directors coolly reassessed whether these investments were wise.

"The Princo board is a very sophisticated group of investors," says John Scully '66, managing director of the California merchant banking firm SPO Partners & Co. "They've been around a long time and have seen a lot of down markets. The visceral reaction when things like this happen is usually to ask, 'Should we redouble the bet?' " In fact, the board did decide to increase Princeton's stake - just in time to catch a rousing, 44 percent run-up in emerging-market stocks over the first six months of 1999.

As the decade closed, it became clear that many of the changes made during Fisher's tenure were paying off like Regis Philbin. As Bogle says, "While the decisions didn't look so good five years ago, last year they looked absolutely brilliant." Take, for example, two asset classes that were new to Princeton when Fisher's chairmanship began:

Hedge funds. Starting from scratch in 1990, Princo shifted nearly one-quarter of the endowment into hedge funds. For several well-known hedge-fund managers, 2000 was a year of disaster. George Soros, who once made over $1 billion in a single day speculating against the British pound, and Julian Robertson of Tiger Management, for years one of the best hedge-fund managers, both suffered reversals and dramatically retrenched. But Princeton's hedge funds consistently kept earning around 20 percent annually.

Why, when the big names fared poorly? Primarily because Princo steered clear of the huge global gambles Soros and Robertson took on commodities and foreign currencies. Instead, it relied on managers who earned consistent profits, a little at a time, by investing on the basis of specialized expertise, such as figuring out when regulators will approve a merger or assessing the worth of a bankrupt company's debt. Not as exciting, perhaps, as speculating against the pound, but more profitable in the long run.

Venture capital. The value of Princeton's venture-capital investments rose to stratospheric heights last year, benefiting from a sizzling market in initial public offerings. Companies that didn't even exist a few years ago were, in early 2000, trading at hugely inflated multibillion-dollar valuations. While this was great news for Princeton on paper, it was also scary. Many of Princeton's shares in these companies were tied up in limited partnerships, subject to restrictions preventing their sale. If the market bubble burst, so would Princeton's profits.

At a meeting in December 1999, the Princo board said, as Scully puts it: "Let's take money off the table as aggressively as possible - and aggressively means now, not tomorrow." Golden and his team canceled their Christmas vacations to construct what Scully calls "an absolutely A+ program" of hedges for each of 22 newly public stocks in Princeton's portfolio.

Less than three months later, these stocks did indeed tumble. Ten fell by 90 percent or more; one dropped 99 percent. The hedging program preserved more than $215 million in profits - "very, very meaningful" money, says Matthews - that would otherwise have evaporated. Princeton's venture-capital investments ended fiscal 2000 up by more than 200 percent.

After Princo closed the books on this extraordinary year last June, the slide that had savaged technology stocks spread to the broader market, driving the S&P 500 down nearly 9 percent by January. Yet Princeton's portfolio was up more than 4 percent. The hedge funds had double-digit returns, while even Princeton's U.S. stocks, tilted toward small companies with a "value" orientation, were solidly in the plus column.

This left the Board of Trustees facing the happiest of problems when they met in late January: The endowment had grown so large that annual distributions had fallen far below the 4 to 5 percent of assets that the university believes it can afford to spend. Hence the ability to increase endowment spending to $284 million for next academic year, with much of the new money going to aid poor and middle-income students, bolstering Princeton's commitment to attracting the best young scholars without regard for their ability to pay. Discussing the "problem" of having too much money, Matthews says, "I told Harold [Shapiro] and the board that the directors and staff of Princo are going to do everything in their power to re-create the same problem all over again."

Most fundamentally, Princeton's financial success, as with that of other major universities, has bolstered its position as an independent source of ideas. Whether in hiring a controversial professor like Peter Singer or in advocating reforms that may offend vested interests, Princeton - girded by the power of its endowment - is better able to propound unconventional thoughts without fear of having its purse strings clipped.


Allan Demaree '58 is a former executive editor of Fortune.

Playing the numbers
Different factors affect endowment measuring

The chart to the right shows that Princeton's endowment has grown some 450 percent over the last 15 years, while Yale's and Harvard's have each grown more than 600 percent. All three are doing remarkably well, to be sure, but if Princeton had amassed assets as fast as Yale, it would now be $3 billion richer. On the endowment express, why is Princeton riding the caboose?

First, the numbers are somewhat misleading. Even though they are "official" - submitted to the National Association of College and University Business Officers and widely quoted as gospel in the press - they are not strictly comparable. Example: Harvard includes in its endowment more than $300 million in pledges, money promised but not yet received. Princeton excludes pledges from its endowment total.

That said, Princeton has still been losing ground faster than its investment performance would suggest. The university's officials like to believe this is because Princeton has spent more of its endowment on current programs than Harvard and Yale. "We are just a little less conservative than our key peers," says President Shapiro.

Unfortunately, that's not entirely correct. Princeton has spent more endowment money per student - about $36,000 last academic year, versus $30,000 for Harvard and $26,000 for Yale - but Princeton's student body is smaller. (Princeton had 6,324 students, while Harvard had 18,541 and Yale 10,870.) When you examine spending as a share of endowment assets, it turns out that Princeton actually spent less last year than the other two schools (3.6 percent versus 3.9 percent for Harvard and Yale).

A major reason for Harvard's growing lead is simply arithmetic. Harvard started the period with over $1 billion more than Princeton, so its investment returns were multiplied by a much bigger base. That factor alone swelled Harvard's lead by several billion dollars.

Gifts are another ingredient. In the last two years, Harvard's endowment took in $487 million, Yale's $221 million, and Princeton's $159 million. "Bigger places just do more fundraising," says Shapiro.

Yale's endowment has been subtly bolstered another way as well. In the last five years, Yale more than doubled its debt to over $1 billion, mainly to finance much-needed campus renovations. By borrowing more, Yale could spend less of its endowment assets.

Princeton has long had bragging rights in one crucial respect - endowment dollars per student (see chart, right). As much as any other single number, this one manifests the university's ability to underwrite a high-quality education. But with the changes in endowment values, Princeton's lead has been shrinking here, too. If the trend continues, it will eventually disappear.

By A.D.

Adieu, Nassau Capital

Nassau Capital was founded on the principle that Princeton could make money by harnessing its interests to those of a small group of high-energy, high-intellect entrepreneurs.

Randy Hack '69 came up with the concept. After a successful career in real estate, he headed Princo's staff until 1995, when the board decided to turbo-charge Princeton's expansion into private equity and real estate. Hack's idea was that he and three partners would make these investments for the university - and for themselves. By investing side by side with the university, they would have a powerful financial incentive to make money for Princeton.

Make money Princeton did. Over five-and-a-half years, the university gave Nassau Capital $2.5 billion to invest. By the end of that time, Nassau Capital had handed $2.3 billion back to Princeton and still held investments worth $2.5 billion to the university.

Nassau Capital invested two ways, through funds and directly in private companies. Most of the money went to 80-odd firms that managed real-estate and private-equity funds. While real estate has been fairly quiescent, many of the private-equity funds exploded in value as the companies they owned went public in the frenzied market of 1999-2000.

While investing with the funds, Hack hoped to discover "coinvestment" opportunities as well - chances to invest directly in some of the hottest outfits the funds owned. One of his biggest hits, for example, came when a couple of Nassau Capital representatives attended a 1997 conference at Accel Partners, a California venture-capital firm, where they met the founder of a small company called Portal Software, in which Accel had already invested.

Portal looked promising. It produced state-of-the-art software that helped Internet and communications companies manage billing and other customer relationships. It also had another attraction. Nassau Capital wanted, as Hack says, "to break new strategic ground for university endowments by aggressively cultivating Princeton's alumni body." As it happened, Portal's founder, John Little, was a member of the Class of 1980.

Hack flew to California to have lunch with Little at an Italian restaurant in Palo Alto. His pitch went something like, "Wouldn't it be great, John, if Princeton could invest in Portal, and if it's a success, this is an additional way you'll really feel good?"

Little cottoned to the Princeton connection, too. "Lots of people have money," he says. "Having Princeton as an investor was a special bonus. For one thing, if we made money for Princeton, I thought I'd never get another call from Annual Giving."

Nassau Capital didn't actually invest in Portal until it had performed due diligence and pulled another Princeton string. Uncertain whether Portal's software would be widely adopted, Hack retained Ira H. Fuchs, then Princeton's vice president for computing and information technology, who quietly sounded out contacts at Microsoft, AOL, MCI, and other potential Portal customers. Hack says Fuchs reported back that, within days, Microsoft was expected to sign an important contract with Portal.

Thus reassured, Nassau Capital invested $4.5 million. Sixteen months later, in May 1999, Portal went public, and Nassau Capital realized a $260 million profit - nearly 60 times its investment. (Like many technology stocks, Portal's shares got clobbered last year, dropping 94 percent from their high, but by then Nassau Capital had made its money and sold out.)

As has been said of the missionaries who went to Hawaii to convert the natives and ended up owning the place, Nassau Capital's partners and employees have done well by doing good. They invested more than $20 million of their own money, and while they won't disclose their profits, their returns should fairly well mirror Princeton's. Princeton earned compound annual returns of 13.9 percent on real estate and 49.9 percent on private equity. And these figures may understate the final results, since most of the direct investments are still carried at cost.

Now the Nassau Capital era is winding down. Though it was highly successful, the potential for conflicts - that the partners might want to make investments Princeton didn't, for example - led the trustees to change the relationship last year (PAW, November 22). Princo took back the fund investments. Hack and partner John Quigley, 46, are putting the firm's remaining cash into direct investments and will "harvest" those already made. Quigley, under the name Nassau Invetment Partners, will continue making direct investments for Princeton.

Once Nassau Capital's operations are wrapped up, Hack's plans are unclear, but he says he feels "extraordinarily fortunate" to have played a major role in the endowment's restructuring and hopes to stay involved with Princeton. "With my daughter just admitted to the Class of 2005," he says, "I won't be far away."

By A.D.