US Endowment Dislocation Creates Compelling Secondary Opportunity

Key Takeaways

• US universities are facing significant financial uncertainty due to proposed federal policy changes that include higher taxation and limits on grant funding
• In response, endowments are seeking to sell portions of their private equity portfolios to improve liquidity and lower duration risk – potentially signaling a structural allocation reduction to the asset class
• This stress comes against a backdrop of three straight years of cyclically low liquidity for the private equity industry, which may adversely impact valuations and deal dynamics
• The dislocation may enable secondary buyers with relationship and information advantages to buy high-quality fund assets at attractive discounts to net asset value

While tariffs have dominated the headlines, it has not led to material stress on private equity portfolios or their investors. However, four unprecedented federal government proposals that target US universities are creating stress for endowments, which are historically large allocators to private equity. As a result, endowments are seeking to shorten the duration and liquidity profiles of their investment portfolios, including selling portions of their private equity portfolios in the secondary market.

Regulatory Crosshairs

Donald Trump’s re-election campaign promised to reform US universities, claiming that they were failing to adequately protect free speech, ensure student safety, and provide balanced and respectful political discourse.

Soon after taking office, the administration proposed four specific actions to catalyze change:

• Raising the tax rate on the income of large university endowments from 1.4% to as high as 21%, as well as possibly revoking university tax-exempt status.¹
• Reducing the cap on federal research grants that can be used to fund overhead expenses from 60% to 15%.²
• Making universities pay for losses stemming from student loan defaults.³
• Immediately freezing and reducing federal funding (and placing scrutiny on foreign funding) until universities agree to meet a specific set of demands.⁴

Some universities are suing the federal government over No. 4,⁵ and the outcome of that remains to be seen. It is also unclear which proposed actions will come to fruition. However, the proposals have created significant uncertainty – and, indeed, panic – for university leaders. To prepare for the worst-case scenario they are cutting expenses, issuing bonds, asking donors for more unrestricted gifts, and seeking additional financial support from their endowments.

Complicated Process

To meet the universities’ request, endowments are seeking to shorten the duration and liquidity profile of their investment portfolios. The task is complicated, since many endowments have adopted an asset allocation model pioneered by Yale’s legendary Chief Investment Officer, David Swenson. The model calls for a high allocation to illiquid assets, namely private equity. Today, about 50% of Yale’s $40 billion endowment is invested in private equity.⁶ While others may not be at this high level, the private equity books of endowments are substantial. To further complicate matters, private equity has just experienced three straight years of cyclically low liquidity.

Rather than a cyclical move, this secondary selling may be the start of a structural reduction in endowment allocations to private equity

Endowments have been engaging intermediaries to sell portions of their private equity portfolios. Bloomberg reported that Harvard is selling $1 billion of its private equity portfolio,⁷ and Yale is actively looking to sell up to $6 billion of its private equity assets,⁸ according to the Wall Street Journal. Others are considering similar action as they struggle to deal with the federal government’s proposals.

Structural Shift?

In more than four decades of investing in the private equity secondary markets, the only prior time we have seen this kind of liquidity pressure on endowments was during the global financial crisis. Even more significantly, rather than a cyclical move, this secondary selling may be the start of a structural reduction in endowment allocations to private equity.

Many private equity sponsors that have raised substantial funds from endowments are now nervous about the prospect of having to fill a huge hole in their future investor base, at exactly the time when many private equity investors are already frustrated by the lull in liquidity.

Buyer Restrictions

During periods of stress, sellers usually look to move their highest quality funds, so as to minimize the discount to net asset value they will absorb. The highest quality funds sit with managers whose fund documents often require their approval for a limited partner (LP) transfer, placing restrictions on who can purchase fund interests. Fund documents are worded in this way to ensure the manager retains control over who is allowed to be an investor in their fund. Endowments therefore need to find approved secondary buyers that can move quickly and provide transaction certainty.

Another preference of private equity managers is that buyers of their fund interests in the secondary market are highly likely to be continuing primary investors in their future funds. This is to limit the future fundraising hole they must fill. As a result, secondary firms that are significant allocators to current vintage primary funds have an edge in winning deals over standalone secondary firm competitors.

Secondary firms that are significant allocators to current vintage primary funds have an edge in winning deals over standalone secondary firm competitors

Secondary firms that are already an investor in the funds being sold have a further edge in underwriting and pricing due to having a prepared mind. They have already performed diligence on, and are knowledgeable about, the applicable general partner’s investment strategy, underwriting guidelines, valuation methodology, personnel, track record, and other important elements that impact the decision to invest.

Compelling Opportunity

Investors seeking to take advantage of this buying opportunity may already need to be in a secondary fund that is still in its investment period, or will need to identify secondary funds that are currently investing while also remaining open to new investors (i.e., not yet at their final closing). In our view, given the discretion of managers to approve or reject potential buyers, the selection process should also prioritize firms that have an active LP investing business that has material portfolio overlap with the high-quality private equity funds that are likely to be sold in the secondary market. We think investors who can secure an allocation to these types of secondary funds stand poised to take advantage of a potentially compelling buying opportunity.

1. New Efforts on Taxing Endowments Raise Questions on Neutrality and Revenue Collection, Tax Foundation, January 28, 2025, Ivy League endowments sell private equity stakes amid buyout downturn, Financial Times, May 19, 2025
2. Supplemental Guidance to the 2024 NIH Grants Policy Statement: Indirect Cost Rates, National Institutes of Health, February 7, 2025
3. Trump Administration Threatens Schools With Student-Loan Restrictions, Wall Street Journal, May 5, 2025
4. Universities Face Full Funding Freezes Amid Trump Administration Demands, Steptoe, April 25, 2025
5. Upholding Our Values, Defending Our University, Harvard University, April 21, 2025
6. Yale seeks to sell billions in private equity investments as political pressures from Trump mount, CT Insider, April 24, 2025
7. Harvard in Talks to Sell $1 Billion of Private Equity Stakes, Bloomberg, April 24, 2025
8. The Economy Is in a Pickle, Wall Street Journal, May 4, 2025

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