Rocketing Returns

Propelled by an astonishing 413 percent gain on its venture-capital  assets, Harvard Management Company (HMC) reported a 32.2 percent  return on investments, after all expenses, for the fiscal year  ended June 30. Including donations received from the end of the  University Campaign, and subtracting income distributed to support  Harvard’s academic operations, that brought the market value of  the endowment to approximately $19.2 billion—a bracing increase  of $4.8 billion from June 30, 1999. 

To put that in perspective, Harvard’s endowment totaled approximately  $4.7 billion at the end of the 1990 and 1991 fiscal years. Although  accounting changes make those figures not strictly comparable  to the current $19.2-billion value, the trend is unmistakable:  during the past decade, the endowment quadrupled. The effect on  University finances is equally pronounced. After representing  about 17 percent of income in the late 1980s, distributions from  the endowment have risen swiftly of late, to more than $550 million  in the fiscal year ended June 30—about 28 percent of revenue.  At a time of slowing growth in tuition income, and relatively  modest gains in sponsored-research funding, endowment distributions  now fuel Harvard’s fiscal engine. 

Returning to investment performance, HMC has achieved higher  returns in only one year (1983) since it was founded in 1974.  The 32.2 percent gain exceeded HMC’s “policy portfolio,” its benchmark  for its 11 asset classes, by 13.6 percentage points—twice the  previous best performance—and exceeded the median results of  other institutional funds with $1 billion or more in assets by  21.8 percentage points. In theory, as a fund like Harvard’s endowment  gets larger, superior performance ought to become more difficult. 

For all his delight in the aggregrate investment results, HMC  president Jack R. Meyer, M.B.A. ’69, emphasized other aspects  of the endowment’s position. The venture-capital gains, he noted,  reflect both tremendous returns on investments and tremendous  distributions from the external managers who oversee these funds  for Harvard. As those investments are cashed out and redeployed  across the endowment’s portfolio, it is somewhat insulated from  subsequent repricing of venture-capital and technology-stock valuations  that he termed “pretty scary.” Combined with the recent very quick  distributions from venture investments, compared with historical  norms—a “somewhat reassuring” development, he added—that means  Harvard’s venture-capital portfolio has “already been a success”  no matter what happens now in the public-securities markets. 

Second, he said, Harvard’s investments are “more diversified  than ever.” In recent years, for example, HMC has steadily decreased  its allocation to domestic equities while creating significant  new investment categories such as absolute return (hedge funds)  and inflation-indexed bonds, which together account for 12 percent  of the overall asset allocation. 

Finally, and most important, Meyer said, “We’re adding value  across asset classes on a consistent basis.” Indeed, following  a disappointing 1999, when HMC’s fund managers fell 6.7 percentage  points short of their benchmark, in fiscal 2000 nearly every part  of the portfolio shone. Emerging markets trailed the benchmark  by a small percentage, and inflation-indexed bonds exactly matched  their benchmark rate of return. All other asset classes excelled  (see chart), including foreign equities (25.9 percent return versus  the benchmark 16.6 percent); private equities, including venture  capital and leveraged buyouts (155.2 percent versus 52.4 percent);  and commodities, especially oil and gas investments (49.9 percent  versus 35.9 percent). 

Ever cautious, Meyer emphasized, “We don’t expect this level  of returns to persist.” His annual letter to the Harvard community  again sounded the note that negative returns are possible—a result  last recorded in 1984, following HMC’s high-water mark in 1983.  However, endowment managers’ real fear, he said, is not the threat  of one bad year but the specter of a period like 1972 to 1981,  when stagnant investment returns, high inflation, and continued  spending to support University operations eroded the real value  of Harvard’s endowment (and everyone else’s) by 40 percent. For  now, nothing makes him that pessimistic. Looking ahead,  he said, 10 percent or lower rates of return could be the norm.  “Earning 100 basis points over the policy portfolio” over the  long term, he said, “would make me a happy man.” 

The Corporation will decide this fall on the endowment distribution  for the fiscal year beginning next July 1. But it is safe to assume  that it will consider a larger-than-routine disbursement, perhaps  along the lines of the 28 percent ($95-million) boost authorized  for fiscal 2000. Routine increases in the distribution have been  more in line with the 8 percent or so effective in the current  year. 

Whatever the Corporation determines, the president who succeeds  Neil L. Rudenstine next July 1 will take office harvesting the  fiscal fruits of a remarkable decade of fundraising and investments.  If Meyer is right, however, she or he ought not count on the endowment  quadrupling again, to $80 billion, by 2010.