John Harvard's Journal
The University’s endowment was valued at $27.4 billion as of June 30, the end of fiscal year 2010--up 5.4 percent from $26.0 billion at the end of fiscal 2009--according to Harvard Management Company’s annual report, released on September 9. During the fiscal year just ended, HMC recorded an investment return of 11.0 percent on endowment and related assets--a welcome improvement from the negative 27.3 percent investment return during the financial upheavals in fiscal 2009, when the endowment’s value declined by nearly $11 billion. The difference between the rate of investment return and the growth in the endowment’s absolute value reflects the distribution of endowment funds to support University operations (about $1.56 billion in fiscal 2010, down from $1.66 billion in fiscal 2009 and $1.63 billion in fiscal 2008), offset by gifts received.
The arithmetic--gross investment gains, less distributions, plus gifts, equals net endowment growth--matters. HMC’s fiscal 2010 investment return handily exceeded its long-term goal: 8.25 percent annual gains. After distributions for University spending (the endowment now provides about 35 percent of operating revenues), the endowment grew at half the rate of the investment return. That is above the rate of inflation: it represents real growth. (The Commonfund Institute’s Higher Education Price Index for fiscal 2010 was a record low 0.9 percent.) But it implies a very extended period of recovery after the $11-billion decline in fiscal 2009. For context, HMC’s annualized rate of return for the past five years is now 4.7 percent, and 7.0 percent for the past 10 years. Those figures reflect not only the fiscal 2009 drop, but also the extraordinarily favorable rates of return (23.0 percent in fiscal 2007, 16.7 percent in fiscal 2006, 19.2 percent in fiscal 2005) realized in some earlier years.
It is this longer-term performance, and the value of the endowment, that shape the Corporation’s budget decisions--significantly including the rate of distribution of cash to support the University’s academic operations. On September 21, the Crimson reported a scoop: Harvard’s schools have been advised to plan for a 4 percent increase in their endowment distributions for fiscal 2012 budgets--reversing direction after 8 percent and 12 percent decreases, respectively, last year and this.
HMC’s performance (after all investment-management fees and HMC operating expenses) was better than the 9.4 percent return calculated using market benchmarks for the assets in the “policy portfolio” (HMC’s model for allocating assets among categories such as equities, fixed-income instruments, real estate, and so on). In fiscal 2009, HMC’s performance trailed its market benchmarks by 2.1 percentage points.
In both years, the University’s portfolio fared less well than a popular measure of large endowment funds, the Trust Universe Comparison Service. Median performance for the TUCS in fiscal 2010 was a 13.3 percent investment return, 2.3 percentage points above the HMC results. The difference reflects dissimilar asset allocations. As HMC president and chief executive officer Jane L. Mendillo explained subsequently, TUCS funds are about half invested in public equities (versus one-third for HMC’s portfolio--where they were among the better performing holdings), with only a few percent invested in real assets (typically almost one-quarter of HMC’s allocation--and this year, the only segment where it recorded losses). Among peers, Columbia reported a 17 percent investment gain, Penn 13 percent, Dartmouth 10 percent, and Brown and MIT both 10.2 percent. Among schools with portfolios most comparable to HMC’s, Yale gained 8.9 percent and Stanford 14.4 percent.
According to Mendillo’s report, investments in U.S. equities returned 17.1 percent and those in developed-market international equities 12.9 percent--both comfortably ahead of benchmark returns. Investments in emerging-market equities returned 17.6 percent, below benchmark returns. (Each of these three public-equity classes is assigned an 11 percent weight in the policy portfolio.)
Private-equity investments were the strongest segment in absolute terms, up 16.2 percent. Although Mendillo indicated that the policy-portfolio weightings for fiscal 2011 will not change, her report indicates a more nuanced view of this asset class. “Private equity bears a mention of its own,” she wrote. “Harvard has benefited from being an early participant in the private-equity arena, and we have a strong team in this area and many important relationships with a number of the best private-equity and venture-capital investors in the world. However, the field of private equity has become more and more crowded--with capital, with managers, and with investors--over the last decade. Our expectations…are that returns will be more muted going forward.” Accordingly, although HMC expects to maintain “a meaningful level of exposure,” those private-equity holdings will be entrusted to a smaller roster of “our highest conviction [investment] managers.”
Returns on high-yield investments (reported within the “absolute return” category) were 19.6 percent, somewhat below benchmark results. That implies that hedge-fund managers’ results--the larger part of absolute-return investments--exceeded their benchmark, but Mendillo’s report does not provide a figure.
Real assets produced investment losses, reflecting the continued weakness in commercial real estate--a segment where HMC’s results trailed market benchmarks. Natural-resources investments (such as timber and agricultural land) yielded a “relatively low” nominal return, Mendillo wrote, but above-market results; commodities returns, she said separately, were nil.
Fixed-income returns (excluding high-yield bonds, as noted) were driven by above-market results in HMC’s internally managed funds, Mendillo wrote. Her report did not categorize returns for the domestic, foreign, and inflation-indexed bond segments.
Finally, the policy portfolio now allocates 2 percent of total assets to cash. (In prior years, HMC borrowed up to 5 percent of its total holdings, using leverage to boost returns; this strategy was obviously unhelpful when financial markets declined sharply.) In a year with positive investment returns but near-zero interest rates on cash instruments, such an allocation would have depressed HMC’s overall results slightly. But the fund managers have the opportunity to deviate from the policy portfolio to some degree, and, Mendillo said subsequently, HMC in fact was fully invested during fiscal 2010. Making cash a formal category within the policy portfolio, she said, imposed a useful discipline on the money managers, who have to be very clear about their reasons for varying from the model parameters, as they identify opportunities to do so during the year for tactical investment reasons.
Mendillo called the year “a successful one for the Harvard endowment” and HMC. She cited the value added in returns that exceeded market benchmarks; improvements in the organization through hiring of new skilled personnel; and changes that “more closely aligned HMC with the University,” after the harrowing months in late 2008 and early 2009 when long-term investments were out of synch with Harvard’s urgent need for cash. She noted “the much improved flexibility of the portfolio we are managing today,” the result of “attend[ing] closely over the last two years to liquidity, capital commitments, and risk management.” Having built up cash during fiscal 2009, through sales of investments and other actions, she said, “We redeployed funds throughout this year.”
In a notable sign of that repositioning, she reported that uncalled capital commitments (contractual obligations to provide funds in the future to real-estate and private-equity investment managers) had been reduced to $6.5 billion at the end of fiscal 2010, down from $8 billion a year earlier, and by nearly a half from the $11 billion at the end of fiscal 2008. These reductions apparently reflect fulfilled obligations plus sales of interests in investment partnerships, maturing investments, and renegotiation of terms with fund managers.
More generally, she added later, across the portfolio, “We have evolved toward more liquidity and fewer long-term lock-ups” of Harvard funds under management. “That has given us more direct access to our capital, so we are able to shift to better opportunities.” For every asset class, HMC has adopted a “much more multilayered approach,” she said, considering liquidity, investment horizon, manager relationships, and other risk factors.
Looking ahead, Mendillo wrote that depressed conditions in the real-estate market have so reduced values that this is now “one of the areas we find most interesting in terms of current and future opportunities.” Mendillo helped launch direct investments in timber and agricultural land when she was on the HMC staff in the 1990s. Now, she said, with new real-estate talent in house, HMC will look beyond limited partnerships in this area, pursuing joint ventures and direct relationships of the sort that have succeeded in natural-resources investing. And she noted opportunities throughout HMC to hire skilled professionals as the financial industry worldwide continues to restructure. As she suggested last year, HMC is likely to increase the portion of funds managed internally: she again cited the advantages of control over assets, staff insights into market conditions, and lower expenses compared to using outside firms.
More generally, she reaffirmed Harvard’s commitment to the “endowment model” associated with Yale, HMC, and other institutions in recent decades: relying on highly diversified portfolios, with significant investments in untraditional and relatively less liquid asset classes where sophisticated investors can realize long-term advantages compared to conventional holdings. “Has the ‘endowment model’ run its course?” she wrote. “Our answer to that question is No.”