private equity investors get pretty much the same return as the
S&P 500. But that picture has changed. Some better data have
come out in recent years. I think the consensus now is that private
equity has something like a 3-percent edge over the S&P 500. But
that’s not great because private equity funds tend to buy small-cap
and mid-cap value stocks, which have shown pretty similar long-run performance as private equity. So it’s not obvious that private
equity investments as a group offer better returns net of fees. There
is no great evidence for illiquidity premiums on private assets.
Why would that be? I think it’s related to return smoothing, which
is a desirable characteristic for many institutional investors. They
can avoid seeing ugly mark-to-market fluctuations, and they overpay for that service. And this overpayment for return smoothing
offsets part of any illiquidity premium.
Geoffrey Gerber: I’m thinking more in general about alternatives
and illiquid investments. When you and your colleagues studied
the Norway model, you highlighted the fact that Norway’s
Government Bond Pension Fund Global invests in virtually the
opposite way from the approach used in the Swensen model or the
Yale model, which some people might call the foundation model.
As you know, the Swensen model is focused on manager alpha,
whereas the Norway model has relied exclusively on publicly
traded securities constrained by low tracking error and little deviation from the asset allocation. Many U.S. pension plans have
invested in various alternative and illiquid investments with varying degrees of success. We know there have been some growing
doubts especially about hedge funds by some of the largest pension
plans. So should U.S. public pensions, as well as high-net-worth
investors, incorporate more of the Norway model approach compared with the Yale foundation model approach?
Antti Ilmanen: The short answer is yes, but let me back up and
say that I like contrasting the Norway and Yale models in two ways.
Norway is 97 percent invested in public liquid investments and
3 percent in real estate. Yale is almost 80 percent invested in less-liquid alternatives, private sector hedge funds, and so on. Norway
manages about 95 percent of its investments in-house. Yale seeks
to delegate perhaps everything to well-chosen, superior external
I think the Norway model works well for institutions that have fewer
resources and maybe less skill or luck or whatever has helped Yale
achieve its great track record. Besides its pioneering role in alterna-
tives, Yale is reputed to be especially skilled at choosing managers,
and I don’t believe that skill can be easily transferred to all its indus-
try peers. The Norway approach is less costly but also less ambitious.
Followers of this model are not passive; they take active risk, though
in relatively modest doses. This cautious approach seems pretty
healthy for many investors inflicted with overconfidence.
Mark Anson: I used to manage the California Public Employees’
Retirement System (CalPERS), so I have to weigh in on this topic.
First, you can’t compare CalPERS or the California State Teachers
Retirement System (CalSTRS) to Yale because of the size of these
funds. CalSTRS is worth about $250 billion. CalPERS is worth
$300 billion. I don‘t know what the Norwegian fund is worth now,
but it’s probably close to $500 billion.
Antti Ilmanen: $800 billion.
Mark Anson: Venture capital, for example, is not going to work for
CalSTRS, CalPERS, or the Norwegian fund because the amount
that can be allocated to the venture capital is too small. It’s not
going to move the needle. The Yale model is smaller, relatively, so it
can be more nimble than a large fund, but that’s an apples-to-pumpkins comparison.
Second, I disagree with the assertion that the Norwegian model is
almost exclusively public. For a long-term investor, whether in the
Norwegian national fund or in CalSTRS or CalPERS, one of the
advantages besides size is a long-term horizon. So investors should
try to capture the liquidity premium as best they can. CalPERS
does that by having a large private equity portfolio, and it now has
approximately $50 billion committed. But they’re just capturing
what is effectively the liquidity premium. Their portfolio probably
includes well more than 100 private equity managers and close to
2,000 portfolio companies, and they‘re capturing the liquidity premium on top of the growth premium.
So, again, comparing Yale with a CalSTRS, a CalPERS, or a Norwegian
fund is simply not a fair comparison. The scale is too big. But I firmly
believe any large institutional investor should grab the liquidity
premium, and that can be achieved passively, which is effectively
what CalPERS does, or more actively, which is what Yale does.
Antti Ilmanen: I agree that there is probably a sweet spot in invest-
ing when it comes to investor size, and Yale may be close to that
sweet spot. Large size can be a two-edged sword, and the
Norwegian fund is on the wrong side in this scale issue. I also agree
that making only public investments is wasteful. As a good starting
point, investors would want to have something like a global wealth
portfolio, and a long horizon would point them toward illiquid
investments. However, there are plenty of investors who view
themselves as perfect long-horizon investors and find it convenient
to accomplish that with private investments and by smoothed
returns, which means that illiquidy premiums are lower than you
“Followers of [the Norway] model are not passive; they take active risk, though
in relatively modest doses. This cautious
approach seems pretty healthy for many
investors inflicted with overconfidence.”