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Harvard finances

Endowment Managers’ Pay Reported—Sort Of

5.18.10

The University released its tax return for nonprofit organizations (Form 990) for 2008 on May 17, and with it, accompanying information on the compensation paid to the Harvard Management Company's (HMC) president and chief executive officer, Jane L. Mendillo, and its highest-paid portfolio managers. Because of a quirk in reporting calendars, much of the latter information turns out to be old news. But accompanying the compensation figures, Mendillo released a statement that has hints of changes in HMC’s pay practices—and, of greater consequence, its dealings with outside investment managers.

First, the pay figures: under the new schedule of disclosure, compensation is now released for calendar years, in accord with IRS regulations, rather than on the basis of fiscal years, HMC’s past practice. Because Harvard is now reporting on calendar year 2008, very little new information is available, other than for Mendillo herself. Mendillo, who assumed her position as CEO on July 1, 2008, just in time for the worldwide financial meltdown (which resulted in a negative 27.3 percent investment return for the fiscal year ended June 30, 2009), was paid $999,114 during calendar-year 2008—essentially, her first six months on the job.

Information on the most highly compensated investment professionals and their compensation reflects what was previously reported on a fiscal-year 2008 basis, because variable, performance-based, incentive pay (“over 90%” of what they take home, according to Mendillo’s statement) is apparently awarded at the end of the calendar year. Thus, in 2008, international fixed-income manager Stephen Blyth earned $6.36 million; domestic fixed-income manager Marc Seidner $6.30 million; domestic equities manager Stanley Zuzic $4.86 million; emerging-markets equities manager Steven Alperin $4.36 million; and natural-resources manager Andrew Wiltshire $3.84 million. These sums may reflect cumulative earnings from strong investment performance during several prior years. (Seidner has since left HMC for Pacific Investment Management Company. Blyth is now managing director and head of internal management for HMC overall. Wiltshire is now managing director and director of external management—private equity, real assets such as timber and real estate, and all externally managed portfolios of marketable securities. See HMC's senior management directory here.) 

Because calendar-year 2009 compensation will apparently now not be disclosed until the University’s next Form 990 filing, in May 2011, it is unknown what the portfolio managers earned during the sharp decline in investment value recorded in fiscal year 2009. Uncharacteristically, during that year, when the value of the endowment shrank by $11 billion, HMC’s portfolios underperformed relative to market benchmarks in several asset classes. For those managed internally, incentive compensation will be sharply reduced.

Money-Management Costs

In discussing compensation, Mendillo’s statement noted that the cost of managing funds internally, through HMC staff, “including all staff compensation, incentive payments, and overhead is about 0.3% of the total assets under management. This compares with an estimated cost of 4.0% (base and performance fees) for a typical hedge fund structure and 1.0% for more traditional long-only management” [i.e., funds that buy and trade securities, but do not sell them short]. Hedge funds and some other asset classes (such as private equity) have, controversially, charged a 2 percent annual asset-management fee, plus 20 percent of earnings realized on the assets managed. Mendillo’s comparison does not explicitly compare the costs of various fixed-income (bond) investment strategies, which are often lower than those for equities and the less liquid asset classes; HMC has traditionally managed a significant share of its fixed-income assets internally.

In the aggregate, she wrote, the lower costs for internally managed funds, versus those assigned to outside managers, “have saved Harvard over one billion dollars in management fees over the past decade.” Given that HMC now manages internally less than half the endowment funds (compared to internal management of about 80 percent of the funds a decade ago, and half the total as recently as 2004), this would seem to imply that, during that period, the University has paid out at least $1 billion, if not considerably more, to external managers, whose fees are not disclosed.

Compensation Changes

As of this July 1, Mendillo wrote, HMC is refining its compensation system. Henceforth: 

• The entire HMC senior management team (not just the CEO) will have “a meaningful stake in the performance of the total endowment portfolio”—that is, performance-based compensation based on relative endowment returns overall.

• Regardless of relative performance (which can result in incentive payments during years of negative returns, if those returns exceed the performance of market benchmarks), HMC has for its senior management instituted “measures to reduce amounts paid in any year when the endowment has a negative nominal return.”

• The entire compensation system will be subjected to annual review by HMC’s chief risk officer, who will report independently to the board of directors. A third-party consultant is also being retained to review HMC’s compensation practices.

External Asset Managers and Portfolio Exposures

Mendillo’s final substantive note addresses external fund managers, where “we continue to actively pursue more favorable terms…across asset classes on subjects ranging from fund-size reduction, to lock-ups and fees.” The reference to fees perhaps covers client negotiations with private-equity and hedge-fund managers industrywide about those “2 and 20” percent payment schemes, which have had the effect of rewarding profits but not penalizing the managers for, or requiring them to share in, losses. The sums involved are, as Mendillo indicated, not trivial.

More consequential for Harvard would be changes in fund sizes and "lock-up" provisions (requirements that funds be assigned to external managers for a specified period, often seven years or so for various categories of private equities, venture investments, etc.). As reported, at the end of fiscal year 2009, HMC had “uncalled capital commitments” to investment managers totaling $8 billion: contractual obligations to advance funds for future investment. Though that was a $3-billion reduction from fiscal year 2008, it still represented an unwanted commitment of future cash flows to relatively illiquid investments, at a time when the returns from such investments (the principal source of funding such future disbursements to the money managers) have slowed to a trickle. Moreover, as Mendillo noted in her report on the fiscal year 2009 investment losses, HMC was using a “larger proportion of strategies with long holding periods” than is now desirable, given Harvard’s lessened assets and heightened liquidity concerns.

Any progress toward reducing future investment obligations (in part by negotiating smaller future commitments and/or agreeing to smaller total investment pools) and enhancing liquidity that way, and through less onerous lock-up periods, would be welcome relief--and could be far more consequential for the University’s financial position than changes in the perennially publicized and debated pay packages for HMC’s staff members.

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