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November-December 2007
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The Endowment: Up, and UpheavalA strong year for investors generally was a very strong year for the University. Harvard Management Company (HMC), concluding its first full year under new leadership, reported on August 21 that the endowment had risen to $34.9 billion during the fiscal year ended June 30 from $29.2 billion 12 months earlier, an increase of $5.7 billion. That 19.5 percent growth is the product of a 23 percent investment return on endowment assets after expenses and fees, plus endowment gifts received, minus the distribution of funds to support University operations. Those glad tidings were almost immediately overshadowed, however, by the unexpected announcement on September 11 that Mohamed A. El-Erian, HMC’s president and CEO since February 2006, would resign at year-end to assume a top management position at Pacific Investment Management Company (PIMCO), from which he had been recruited to Harvard in 2005 (see below). The performance of the endowment matters more than ever. During the fiscal year, distributions from the endowment to fund faculty salaries, financial aid, research, library acquisitions, and the like exceeded $1 billion for the first time. (In fiscal year 2006, the sum disbursed was about $930 million.) These funds now represent more than 30 percent of Harvard’s operating budget—a substantially larger fraction than tuition and fees, support for sponsored research, or any other source. (An additional $140.5 million was set aside for the “strategic infrastructure fund,” a 0.5 percent levy on the endowment for Allston campus development.) • Investment returns. In his annual letter on the endowment, El-Erian noted that during the fiscal year, the Standard & Poor’s 500 index returned 20.6 percent, and the Lehman Aggregate—a common bond-market metric—6.1 percent. HMC’s 23 percent return was a full 5.8 percentage points above what Harvard would have earned had its diversified portfolio simply matched the market performance of each asset category in which the University invests (domestic and foreign equities, emerging-market stocks, domestic and foreign bonds, real estate, and so on; for the actual composition of the portfolio as of June 30, see the investment section of Harvard’s financial report at http://vpf-web.harvard.edu/annualfinancial). The extra returns augmented the endowment by $1.7 billion. That large margin of added value boosted Harvard’s performance well above the median return of 17.7 percent in the Trust Universe Comparison Service, which aggregates data on 151 large institutional investors. (Nonetheless, El-Erian expected some other universities to report higher returns, given their relatively greater proportional investment in private equities and real estate—both exceptionally strong last year. Indeed, Yale reported returns of 28 percent during the period and Amherst only slightly less; the University of Virginia, 25 percent; and Dartmouth 23.7 percent.) HMC no longer provides yearly returns by asset class. Instead, it offers five- and 10-year annualized performance; El-Erian said other investors could use one-year data to gain insight into certain Harvard strategies. He did disclose that among all asset categories, emerging-market equities produced the highest return for the year (44 percent), followed by private equities and real estate (both of which returned more than 30 percent). As for the dollar contribution to the growth of the endowment—reflecting the size of the portfolios as well as the rate of return—the most significant assets were emerging-market equities, domestic and international equities, and absolute-return funds (hedge funds managed to have a neutral posture toward the market overall). 
• The new order. The fiscal year 2007 results constitute an initial performance report on the investment disciplines El-Erian and new HMC personnel have put in place since his arrival. Reviewing historical data on Harvard’s general investment account (which includes the endowment), El-Erian said the 23 percent rate of return had been exceeded only seven times since fiscal year 1971. The 5.8 percentage point margin over market returns had been exceeded only three times: in 1988 and 2001, when market returns generally were negative, and in 2000, when Harvard harvested billions from venture-capital investments during the dot-com bull market. He attributed HMC’s outperformance to several factors. First, the allocation of endowment assets has changed, placing more emphasis on international equities and alternative categories of investments, and much less on fixed-income holdings (see chart above). Those shifts, driven by HMC’s long-term investment perspective, were augmented by daily portfolio-management decisions that buffered the effects of several sharp market down-drafts during the year. 1 | 2 | continued >  
 
 
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