Ghost Money: Our Endowment Problem 

The Dartmouth College endowment looks like a fortress of financial might, with a record-breaking valuation of $8.3 billion, as shown in the school’s November annual report. This number provides the confidence for college administrators to withdraw hundreds of millions of dollars annually for scholarships, faculty salaries, and campus expansions. Yet this spending relies on a dangerous assumption. There is an unseen risk that a significant portion of this sum exists only as accounting fiction rather than as realizable cash. In other words, the College is calculating its annual budget based on wealth that does not exist. When the accounting finally aligns with reality, the sudden disappearance of that wealth could force the administration into severe austerity measures and painful cuts down the road.

To understand the precipice upon which Dartmouth’s and all major endowments may now stand, one must first look back to New Haven in 1985. Before that year, institutional investing was a sleepy, largely standardized affair. University endowments, pension funds, and foundations largely adhered to a rigid “60/40” split: 60 percent in domestic public equities and 40 percent in high-grade bonds. The (supposed) negative correlation between these two asset classes was appealing for endowments as it lowered portfolio volatility, which was expected to increase long-term returns via reducing what is known as volatility drag. Then came David Swensen.

Swensen took over the Yale endowment in 1985. He was a 31-year-old former Wall Street bond trader with a Ph.D. in economics. He looked at the traditional 60/40 model and saw a massive inefficiency. He argued that universities, unlike retail investors or banks, had a distinct advantage: an effectively infinite time horizon. Because Yale did not need to liquidate its portfolio next week or next year to pay a mortgage, it could afford to lock up capital for decades.

Swensen recognized that the public markets (stocks and bonds) were “efficient,” meaning information was widely available and priced in, making it incredibly difficult to consistently beat the market. Private markets, however, were wild, inefficient, and largely untapped by institutional capital, as the limited partners of the investment funds of the time were far less patient, demanding their money back as soon as possible.

Swensen’s revolution, which became known as the “Yale Model” or the “Endowment Model,” was built on a simple yet contrarian premise: liquidity is expensive. If you want the ability to sell an asset at a moment’s notice (like a share of IBM), you pay a premium for that privilege in the form of lower expected returns. Conversely, if you are willing to lock your money away in a private equity fund for ten years, you should be compensated with higher returns. Swensen coined this the “illiquidity premium.” Under Swensen’s model, Yale aggressively lowered its allocation to domestic stocks and bonds. Instead, capital flooded into alternative assets.

For decades, Swenson’s model appeared to greatly benefit Yale. The school generated staggering returns, averaging 13.7% annually over his tenure and growing the endowment from $1 billion to over $31 billion. It was a financial triumph that allowed Yale to develop its departments and become the well-renowned name we still know today.

Throughout the 1990s and 2000s, investment committees at nearly every major university, including Dartmouth, looked at Yale’s numbers with envy. They saw the massive benchmark return generated by Swensen and concluded that Swensen’s model of asset allocation was the way to go: if Yale invested 30% in private equity and 20% in hedge funds, then they needed to do the same.

This triggered a massive phenomenon of “herding” behavior. Endowments across the Ivy League and beyond dismantled their liquid public portfolios and piled into private alternatives. As Dartmouth, Harvard, Stanford, and eventually even public pension funds crowded into the space, the “illiquidity premium” began to compress. Too much money was chasing too few good deals. By the 2010s, the Swensen Endowment Model had become the industry standard. Endowments had become heavily overweight in private equity and private credit.

This feature (or bug) allowed endowments to report smooth, low-volatility returns, for the private valuations didn’t fluctuate wildly like the stock market. However, this widespread adoption created a hidden systemic risk: when every endowment is allocated 40%, 50%, or even 60% to illiquid assets, they lose the ability to maneuver. They become dependent on “distributions,” or cash flowing back from these private funds, in order to pay for university operations.

This brings us to the present danger. The nation’s leading colleges and universities have locked themselves into a crowded trade during a changing economic cycle. The “illiquidity premium” that Swensen captured in the ’90s relied on a functioning exit market to return cash to investors. As the illiquidity premium vanished, and investment firms could no longer make money by converting a private company to a public one, many have decided to stay private for longer with the same optimistic private-to-public conversion arbitrage baked into their valuation.

Private equity and venture capital firms typically operate on the “2 and 20” model: a 2 percent annual management fee on assets and a 20 percent “carry” or performance fee on profits. Crucially, this fee is often charged on the current estimated value of the portfolio. Furthermore, a firm’s ability to raise its next fund depends entirely on the reported performance of its current one. This creates a perverse incentive structure where managers effectively grade their own tests. Unlike public stocks, which are priced every second by millions of anonymous buyers and sellers, private assets are “Level 3” assets. Their value is determined quarterly by the very managers whose fees and reputations depend on those numbers being high. The industry employs what is cynically known as “volatility laundering,” keeping valuations smooth and steady on paper while the real world fluctuates wildly.

The secondary market is where institutional investors, desperate for liquidity, sell their stakes in private funds to other investors. Liquidation data reveals that when endowments try to offload these “premium” private equity stakes to raise cash, they are often forced to accept significant discounts. While managers report their funds at 100 percent of NAV, secondary buyers are often only willing to pay 60 to 85 cents on the dollar, showcasing skepticism toward the fair value of those funds.

This brings us to the risk now facing Dartmouth. The endowment reports a valuation of $8.3 billion, a number heavily buoyed by private marks that have likely not been subjected to true market discipline. If Dartmouth attempts to access this capital, it will be forced to accept the secondary market’s discount, instantly vaporizing hundreds of millions in reported value.

But the deeper, more terrifying reality is not just that the money disappears when you touch it. It is possible that a billion dollars were never there to begin with. It was merely a paper fiction invented by fund managers that allowed everyone to feel wealthy while the fees were being paid.