Universities Shouldn’t Be Punished for Betting on Private Equity

Moody’s Investors Service recently released a report bluntly entitled, “Private equity exposure increases credit risk for universities with limited wealth.” This is not an opinion by a columnist like me; it will be read as an order in all but name from an organization that influences credit access and interest rates paid by smaller universities. It might as well have been titled, “If you’re not Harvard or Yale, you had better get your endowment out of private equity or worry about your ratings.”

The report isn’t subtle. On page 3 is a chart with names redacted of 59 universities with smaller endowments that Moody’s rates. Board members of all those universities can easily find their school based on its numbers and see where it ranks on the naughty list.

Of course, part of Moody’s responsibility is to inform creditors and lenders about factors that influence its ratings. And there are plenty of risks associated with putting 30% of an endowment in private equity. It’s just that credit isn’t one of those risks.

The report begins with noting that private equity is less liquid than public equity, which no one denies. No explanation is given about how that relates to credit risk. One major credit risk is a liquidity crisis — not having the cash you need to pay wages or service debt. If a school is counting on endowment income to pay its bills and that income doesn’t materialize, it could find itself in default.

But no one counts on private equity investments for income cash flow. Typical investments pay nothing or even consume capital for 10 years or so, and then pay capital gains on an unpredictable schedule. You can’t be disappointed by the cash flows of an investment from which you didn’t expect cash.

If a school put its endowment in high-yield bonds and earmarked the income to pay bills, then it could face credit problems if some of the bonds defaulted. If the school planned to sell public equities for income, and the stock market tanked, it might be in trouble. But private equity cannot cause short- or medium-term cash flow problems.