Has Harvard’s Endowment Stopped Growing?

Interpreting possible investment returns

Trees don’t grow to the sky. Nor, apparently, do financial investments. After several years of relatively robust returns on endowment assets invested by Harvard Management Company (HMC)—15.4 percent in fiscal year 2014 (ended June 30 of that year); 11.3 percent in FY 2013; (0.05) percent in FY 2012; and 21.4 percent and 11.0 percent, in FY 2011 and 2010, respectively, during the brisk recovery from the 2008-2009 financial crisis—more modest results may be in store. Recent reports by institutions whose past returns have been useful proxies for HMC’s results suggest much more subdued appreciation in FY 2015 than during the preceding two years, with low-single-digit rates of return (see details in “Other Institutions’ Returns,” below).

HMC will likely report FY 2015 results several weeks into the new academic year. Its rate of return matters, of course, because:

Distributions from the endowment continue to provide about 35 percent of the University’s operating income: $1.54 billion of the $4.41 billion in revenue reported during FY 2014 (the most recent year for which Harvard has disclosed its financial results). As the financial report notes, the University now adheres to a rule that has the effect of “smoothing the impact of annual investment gains and losses.” Thus, the slightly negative rate of return on endowment assets in FY 2012 had the effect of constraining the growth in fund distributions, and thus on University and school budgets, in subsequent years.

If FY 2015 results are significantly below those recorded during the past couple of years, that may dampen growth in future distributions for operating purposes. (The FY 2014 distribution grew just 2.7 percent from the prior year—in part reflecting the slightly negative endowment returns in FY 2012.)

•Moreover, given the annual distributions just cited, it is possible, in a year of low investment returns, that the endowment’s value could be flat, or could even decline. As of June 30, 2014, the endowment was valued at $36.4 billion—within a half-billion dollars of the peak realized in FY 2008, just before the financial crisis.

The endowment’s value also reflects new funds received, of course, and The Harvard Campaign has yielded multiple multimillion- and even centimillion-dollar gift announcements. During FY 2014, gifts for endowment funds were $513 million, up from $223 million in the prior year; as of June 30, 2014, before the announcement of several blockbuster gifts, endowment pledges receivable were $546 million, up from $355 million a year earlier. As those data suggest, campaign-related gifts are already augmenting the endowment, but there are important timing considerations: many large gift announcements are indeed in the form of pledges, entailing a lag, sometimes substantial, in the receipt of actual funds, and a further lag in the subsequent recording of those payments as invested endowment assets.

Allowing for these timing differences and excluding the effect of any gifts received (a potentially large wild card during a successful capital campaign), a back-of-the-envelope calculation reveals that if the FY 2015 rate of return were 4 percent, yielding gross investment gains of about $1.5 billion, and distributions for operations were at or slightly above the prior-year level, the value of the endowment would be roughly flat to slightly down.

Other Institutions’ Returns

In recent years, two institutional investors that report preliminary returns during the summer have suggested the environment in which HMC’s portfolio professionals and external investment advisers operate:

  • The huge California Public Employees’ Retirement System (CalPERS) reported preliminary FY 2015 returns of 2.4 percent, down from 18.4 percent in FY 2014 and 12.5 percent in FY 2013 (when HMC’s returns were, as noted above, 15.4 percent and 11.3 percent, respectively). CalPERS cited strong investment results for real estate (approximately 13.5 percent) and private equity (8.9 percent)—both valued as of March 31. Another category of tangible assets, forestland, produced a slightly negative return. “Global equity,” its stock investments, yielded 1 percent, in the face of “the strengthening of the U.S. dollar versus most foreign currencies, as well as challenging emerging-market local returns.” Fixed-income assets (public bonds), earned a 1.3 percent return.
  • The Massachusetts state pension fund reported 3.9 percent returns for FY 2015, down from 17.6 percent and 12.7 percent in the prior two years. Real estate (12 percent return) and private equity (15.6 percent) were the stand-out categories. U.S. stocks returned 6.8 percent, but developed-economy foreign stock returns were negative 2.8 percent and emerging-market stocks were weaker still, returning negative 5.9 percent. Fixed-income returns varied by strategy, from positive 4.7 percent to negative 4.7 percent. Timber and natural-resources holdings (which may include assets in the very weak energy sector) returned a negative 1.4 percent, and hedge funds (often included in portfolios to counter market returns) produced a positive return of 3.7 percent.

These institutions’ needs, investment strategies, and execution naturally vary from HMC’s, but the directional change from FY 2014 to FY 2015 is certainly suggestive. More broadly, market indexes behaved similarly: the Standard & Poor’s 500, a proxy for the U.S. stock market, was up for the year ending June 30, 2015, but international and emerging-market benchmarks declined. Broad bond-market benchmarks were up, but global sectors declined, especially when translated into appreciating dollars.
Real-estate and hedge-fund measures track with the pension funds’ results shown above.

Moreover, the Wilshire Trust Universe Comparison Service—a broad measure of North American institutional investment portfolios, published by Wilshire Associates—reported that larger plans (those with more than $1 billion of assets, and therefore more likely to be diversified beyond the U.S. markets and public securities holdings) had median returns of 3.24 percent for the fiscal year ended June 30. Among large foundations and endowments, the return for the period was 3.58 percent.

Harvard Management Company’s Portfolio, and the Importance of Endowment Appreciation

As a scorecard for keeping track of HMC’s results when they are announced—or for anyone who wishes to switch from fantasy baseball to “fantasy investing” in light of reported benchmark returns and other institutions’ reported performance—its “policy portfolio” (its model for allocating assets) calls for investments to be distributed as follows, in pursuit of an expected long-term rate of return of 7.4 percent:

Public Equity

 

    Domestic

11 percent

    Foreign   

11 percent   

    Emerging Markets

11 percent

Private Equity

18 percent

Real Assets

 

    Natural Resources

11 percent

    Real Estate

12 percent

Absolute Return
(hedge funds)

16 percent

Fixed Income

10 percent

At and just after its peak value at the end of the last decade, the endowment was providing fewer dollars to support operations than it is today. But Harvard in 2015 is a bigger place, with more buildings to run, more financial-aid spending, higher compensation and benefits expenses, and so on. If, as a result of diminished investment returns and the current rate of distributions, the value of the endowment appreciates only very slowly (or remains flat, or even declines), that heightens the importance of securing capital gifts during the fundraising campaign, to sustain the University for the long term. 

Read more articles by: John S. Rosenberg

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