Cash is King
Reassessing the Liquidity Trade-off in Markets
“I don’t think the strategies that we have employed over the past 40 years are going to work going forward.” — Marc Rowan, CEO, Apollo
“One thing, though, is certain: success over the next four decades will look different than success over the last four.” — Matt Mendelsohn, CIO, Yale
John Maynard Keynes had been running the endowment at King’s College, Cambridge, for 15 years when he published his masterwork The General Theory in 1936. After starting as a macro investor with a focus on market timing, he gradually shifted his approach towards bottom-up stock-picking with improved results. “As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes,” he wrote in a letter to a fellow investor in August 1934.
By the time The General Theory was released, Keynes was on a run of seven straight years of outperformance, having reduced portfolio turnover to around 30% per annum from 55% in the 1920s. His best year came in 1935, when his discretionary portfolio gained 34.0% against a market up just 7.2%. Yet despite his success as a long-term investor, Keynes was troubled by the speculative nature of markets. He wondered if the job could be better done if investment decisions were “permanent and indissoluble, like marriage, except by reason of death or other grave cause.”1
Fifty years later, another endowment manager picked up on the idea. David Swensen took over as chief investment officer of Yale University in 1985 and identified private investment as a natural extension of Keynes’ thinking. “While falling somewhat short of the gravity of the decision to marry, funding a private equity firm represents a long-term commitment,” he wrote in his book, Pioneering Portfolio Management.
Although his high allocation to illiquid investments would become a hallmark of the Yale Model of endowment investing that he pioneered, Swensen’s rationale was more opportunistic than philosophical. “Rewarding investments tend to reside in dark corners, not in the glare of floodlights,” he observed, noting how Wall Street’s focus on trading volume left less liquid markets underexplored. “Because market players routinely overpay for liquidity, serious investors benefit by avoiding overpriced liquid securities, and by embracing less liquid alternatives.”
By the time he died in 2021, Swensen had shifted 51% of Yale’s investments into illiquid assets. His target was that venture capital should comprise 23.5% of the fund, leveraged buyouts 17.5%, real estate 9.5% and natural resources 4.5%. The strategy worked. Over his 36 years running it, Yale produced an annualized gain of 13.7% per annum. In dollar terms, outperformance during Swensen’s tenure represented over $50 billion in value added relative to the average endowment.
Yale hasn’t provided an asset allocation update since but in 2023, Swensen’s successor Matt Mendelsohn reiterated his commitment to less liquid alternatives: “Our ability to be patient with long-term, illiquid assets will continue to be one of Yale’s key competitive advantages and central to our investment approach.”
“That said,” he added, “illiquidity does not, in and of itself, produce excess returns.” With returns having slipped in recent years – last year the fund was up just 5.7% – he no doubt recognizes that unlike in Swensen's early days, private investments no longer constitute a dark corner of the market. Endowments now allocate around 40% of their funds to illiquid assets, according to the latest industry survey. Public pension funds have followed – as we explored in KKR’s Berkshire Dreams – and even retail investors are starting to gain access, a development we examined in Private Equity for the Masses.
Now, Yale has confirmed that it is considering selling a portfolio of private equity on the secondaries market. The sale, potentially worth $6 billion, could represent about 15% of the fund, which stood at $41.4 billion in June 2024. Like other universities, Yale faces potential challenges linked to the new Trump administration, which has pulled or placed under review more than $10 billion in funding as part of its push for sweeping changes to how universities operate. But with the sale likely to come at a 10% discount to net asset value, it highlights a deeper truth about illiquidity: the inability to respond quickly to changing circumstances comes at a cost. That cost may be rising in today’s more volatile environment, forcing investors to reassess the trade-off between illiquidity premiums and strategic flexibility.
To explore the ramifications of this shifting calculus, read on.