Endowment Fund-led Investments

A growing narrative over the last year has been the emergence of interest in crypto assets by university endowment funds. Just in the last few months, the news broke of Harvard Management Company’s purchase of 95,833,333 Stacks Tokens (the native token of the Blockstack blockchain) alongside two other funds. Several months earlier we heard reports of the Yale Investment Office’s investments in Andreessen Horowitz’s crypto asset-focused fund and Paradigm – the $400 million crypto fund founded by Coinbase co-founder Fred Ehrsam and former Sequoia Capital partner Matt Huang. Moreover, there is reason to believe that many other university endowment funds are beginning to test the waters with crypto asset investments, with notable examples including the endowment funds of Stanford, MIT, and Dartmouth.

A superficial argument would suggest that these inflows of institutional capital may represent the beginning of the next bull run within the industry, but we think there is much more to unpack. This article will assess the important role that university endowment funds play within capital markets and seek to explain what impact their entry into the crypto asset industry might have.

Put simply, endowment funds are investment funds established by a foundation that makes consistent withdrawals from invested capital – with the most significant example being that of university endowment funds. These types of funds are noteworthy due to their ties to some of the most prestigious and long-standing institutions within the United States, such as the Ivy League universities or the University of California system, as well as the vast amount of funds they have available to invest due to donations garnered over the years.

In 2009, not long after the recession, the value of the top 200 university endowment funds in the United States was just under $280 billion. The above chart plots the endowment fund sizes from 2008 to 2017. It shows that by 2013 the total value had increased to around £370 billion. By 2017 it had reached $500 billion. Given the size of this sector, university endowment funds play an important role both as principal investors and as limited partners within other funds.

Endowment Funds as King Makers

This dual role of university endowment funds can best be exemplified within the crypto asset firm through the aforementioned investments made by the Yale Investment Office and Harvard Management Company. The Yale Investment Office and its Chief Investment Officer, David Swensen, have gained a reputation for delivering consistent market-beating returns whilst also actively seeking to invest in ‘unconventional assets’ which have included Google and Amazon in the 1990s, and investments in Facebook, LinkedIn, and Airbnb more recently. Moreover, the Yale Investment Office could be argued to be playing a King Maker role in its venture capital investments which are reported to have had an internal rate of return of 165.9% as of June 2018. Some of the notable venture capital funds which they are limited partners in, include Andreessen Horowitz, Benchmark, and Greylock Partners. The pie chart below shows the breakdown of both Harvard’s and Yale’s endowment fund investments by asset class. The chart helps demonstrate how the proportion of PE, VC, & alternative investments for these two endowment funds in particular is on the continued uprise (Harvard : Left, Yale : Right).

The story of Yale’s investment can, in fact, be attributed largely to their investments in venture capital (as well as real estate) where they have historically had an oversized allocation compared to the educational institutional mean. Moreover, much of Yale’s venture capital success is considered to be a result of the outsized success of certain software and internet companies within their venture capital investments’ portfolios. Yale’s investments in Paradigm and A16z Crypto are signs of their expectation of similar opportunities within the crypto asset space. Most of the narrative around Yale’s endowment fund investments has focused on the impact of their unconventional investment style on their portfolio but nothing has been said about the impact of their investments on the venture capital firms they invest in – in other words, their role as a kingmaker.

As much as the venture capital industry is one of product knowledge, technical proficiency, and grit, the success of a venture capitalist can also in part be attributed to their ability to network and signal to generate deal flow. A venture capitalist can signal in a variety of ways: having a good investment track record, through unique thought leadership or having previous success as an operator at a well-known company. Perhaps, an under-recognized but all-too-important alternative signal is a person’s ability to draw in prestigious limited partners. If so, there is a no more prestigious limited partner than the endowment fund of an Ivy Plusⁱ institution. These institutions control a disproportionate amount of the total capital amongst educational institutions, as is shown below.

Before we switch focus to Harvard’s investment in Blockstack keep this one point in mind. Yale’s investments in A16z Crypto and Paradigm can be argued to have anointed them as kingmakers for the crypto asset industry. One shouldn’t be surprised to see future projects with the most promise, first go past the desks of Paradigm and A16z Crypto before they reach those of the more long-standing crypto asset funds. The implications of this, as well as the apparent dissonance between the nature of venture capital investing and that of crypto’s ostensible focus on the decentralization of finance, is important.

Vanishing hurdles for institutional capital

Harvard Management Company’s (HMC) purchase of Stacks tokens represents the first noticeable, and therefore highly significant, example of an endowment fund directly investing in a crypto asset. This was likely made possible by the fact that Blockstack applied for a Regulation A+ exemption for their token without which the regulatory uncertainty may have prevented HMC from making the investment. This also signals the fact that such an approach ­– using a Regulation A+ exemption – may become more commonplace among projects looking to conduct token crowdsales which allow for institutional capital.

Squaring private investing and the decentralization of money

This article has used recent investments by the Harvard Management Company and the Yale Investment Office to illustrate the important role that university endowment funds play within capital markets. It has also shown that their entry into the crypto asset industry has positioned them as likely kingmakers for the industry. Certain parts of this analysis may seem at odds with the promise of decentralized finance (and alternative funding models) which partially acted as the impetus behind the 2017 token sale craze. Two dissonant themes stand out in particular: (1) the conflict between open and free internet-based financial markets and the necessity for financial market regulation; (2) the paradoxical role of private early-stage investment in nascent internet protocols.

The conflict present in (1) is that of a Double Movement inherent in crypto asset regulation. Regulation allows the potential benefits of tokenization, such as lowered operational costs and the potential of funding open-source protocols, to be married with the consumer protections that securities law brings. The conflict in (2) is slightly more interesting. The first wave of private venture firms who invested in tokens benefitted from token pre-sale discounts with much shorter timeframes before the asset’s availability to public markets. Such opportunities are unlikely to exist going forward and, as the crypto asset funding market begins to morph into something more similar to traditional capital fundraising, many of the first vanguards of crypto asset funds may be crowded out by the better credentialed ‘Kings’ of A16z Crypto and Paradigm. In this case, many crypto asset funds face existential risk. In addition, the role that the retail investor will play in crypto asset capital markets is left uncertain given how much of the last retail wave of investing was driven by the unsubstantiated promise of venture capital-like returns.