1.

The private equity industry is changing, as shown by:

a. The focus of most funds as of 2006 was to create multibillion dollar

buy out funds whose aim was to make safe and low risk (and low
return) investments so that raising of follow on funds was easy. This
drove the pupose of the fund away from ‘adding value’ thru
innovation. Furthermore, this activity saw massive manager
defections to start similar funds of their own and hence entailed a
‘manager risk’.

b. Funds were positioning themselves as asset managers, and

therefore had low hurdle rates and looked for invesmtents which
were much safer than the routine private equity targets.

c. The increasing availability of capital in the industry was also a point

of concern. This compounded the demand for good funds by limited
partners and access to the best funds was nearly absent. The
market was essentially heating up.

Swenson’s strategy could backfire in 2 ways:

a. He does not get the return he wants as funds’ way of working is

changing into something similar to modern day asset managers

b. An overheated market could reduce returns and drive up management

fees and other transaction costs, effectively defeating the argument for
investing in private equity in the first place.

2. We believe that Swenson should maintain the endowment’s exposure to

private equity, but look to invest in emerging markets rather than in
developed ones. This has the following rationale:

a. As with any boom-bust cycle, the rampant availability of capital and

middle men fees all indicate a coming decline in the market, while
the same cannot be said of emerging markets. Swenson should
leverage his relationship with his PE fund managers and divert more
of his asset allocation to emerging markets.

b. Swensons’ PE fund managers have so far shown great talent in

adding value to buy-out targets and have shown prudence in
investing. We believe this behaviour does not ‘go with the flow’ and
can yield high returns if pursued in the same diligent manner.

c. Since any PE investment is an essential lock out of capital for 5-10

years, emerging markets and their growth potential can deliver
massive returns to the endowment.

In posterity, given that the worst financial crisis of recent times was to hit
in less than 2 years from the time of this case, one can argue than less
exposure to risky assets was prudent, but we disagree as this pull out
would entail friction in the endowments’ relationship with its asset
managers, and could preclude Swenson from future fund raising.

Now, in 2011, our recommendation for the strategy would not change, and
we continue to recommend that Swenson increase his exposure to PE as a
whole and PE in emerging markets in particular.