MANAGING HARVARD'S MONEY

When a button marked "HARV" flashes on the telephone switchboard in almost 50 investment banking firms on Wall Street, stock traders know that the nation's richest university wants to do some business. At Harvard Management Company (HMC) in Boston's financial district, one of the four traders simply places a call on one of the 90 direct lines to the money moguls to ask, "What's your market in stock X, Y, or Z?" Through such second-long transactions, Harvard traders shuffle around an average of $4 million each day. In the last three months, under HMC's care, the endowment raked in a 10-cent profit for every dollar moved in daily trading.

HMC has made it to the major leagues in money management. Established in 1974, HMC is one of the country's only in-house management firms for a university. Other universities find that hiring outside money managers and paying them a percentage of assets each year is more cost effective than setting up an in-house operation, but Harvard allocated almost $10 million last year to pay managers to invest its own money. And as the University's money traders push the endowment past $3.5 billion, HMC is making a name for itself in investment banking circles.

"We are an investment management company," says Walter M. Cabot '55, president of HMC. The difference is: "We happen to manage Harvard's account."

While Harvard's account is not the biggest one around, it's still large enough to attract notice.

"The benefit of having that much money is that Harvard can be on that [institutional] level. That much more volume and money commands that much more attention," says Charles Harvey, an investment executive at Paine Weber in Boston. It's not only volume though; "Harvard commands that much more attention," he says.

"It's an advantage for Harvard students because the endowment gets bigger with shrewd investment," Harvey notes.

According to Dean Hilzenrath, vice president of Morgan Stanley, his firm has direct lines to about 150 clients around the country. Harvard is one of these clients. "Harvard is on the list of large institutional clients of major investment banking firms; for sure it's in the top 200," says a senior partner at one Wall Street investment firm who asked not to be idenitified. "Major investment firms all have major trading relations with Harvard just like any major managers," he notes.

JUST ANOTHER CLIENT?

To the 100 Wall Street securities firms HMC deals with, Harvard is "just another client," on par with other multi-billion dollar fund managers, such as Putnam Mutual Fund in Boston which handles $25 billion.

But instead of maneuvering around private pension funds, the 102-member staff at HMC guards a portfolio that pays professors' paychecks and student financial aid. Twenty percent of the return on investments in 1984-85 helped bankrolled the University's $650 million budget, while the rest was reinvested.

In recent years, the endowment income has begun accounting for a lower proportion of the University's budget. As a result, tuition has risen and begun accounting for a larger segment of the budget. Over the last 10 years, HMC reinvested income on the endowment to to help offset the inflation rate, but at the same time University expenses were growing and outstripping the amount of endowment income allocated to the general budget. The endowment, which paid for 22 percent of the University's expenses in 1974, only funded 18 percent last year. Tuition increases above the rate of inflation have had to make up the difference: in 1974, tuition paid for 21 percent of the University's expenses and last year, 26 percent. Next year, dergraduate tuition will rise by 6.9 percent compared to the 1985 4 percent inflation rate and the current negative inflation.

In letting tuition pay for a larger part of expenditures, Harvard's money protectors are trying to keep the endowment growing at a stable pace and hedge for a time, of higher inflation for example, when Harvard might need more money from the endowment. "We could spend more from the endowment and reduce tuition, but we have to spend for the long haul," says Financial Vice President Thomas O'Brien.

The need to protect the endowment's purchasing power from market and inflation fluctuations can also guide the way Harvard invests. "Universities live to a certain extent off endowments," says Nicholas Potter, head of investments for J. P. Morgan and Company. "They take a different approach than pension funds and tend to be more conservative because they can't take risks in the long term."

But that doesn't slow down the action at HMC headquarters. "[HMC] has been know to take risks," says Stanley's Hilzenrath. "They're smart people who do a lot of sophisticated trading in common stocks and options--which fits the kind of business we're in."

ON THE JOB

With the help of Wall Street research, 15 HMC analysts decide how to invest Harvard's billions. Corporate histories, product break-downs, and earning estimates compiled by investment brokers plus 10 calls a day link the analysts to the researchers.

"We look to Wall Street for fact-gathering," says Cabot. "Our people spend most of their time assessing the reliablitiy of fact-gathering, the value of stocks and overall management of certain companies. Our value added is interpreting the facts."

Cabot adds that his desk is now piled with information from Wall Street.

After the analysts wade through the research and determine which securites to add to the investment portfolio, the Wall Street-HMC connection moves to the trading floor. Traders buy and sell securities via direct lines to brokerage houses, making between 50 and 75 calls each day and fielding more than 100 calls.

"It's a lot easier to push a direct line button than make a phone call," says one equity HMC trader. "Speed is of essence when you try to sell or buy stocks,"

"All we do is hit a button, and we're directly into Goldman Sachs," says Cabot. "A direct line gives time, speed, convenience, and not much more than that."

The direct hook-ups to Wall Street brokers are "so much a part of day to day operation, it's just like you going to the library and getting books out," Cabot says.

Besides using direct lines for stock transactions, traders "exchange information" over the phone, says an HMC equity trader. "Someone might call up to ask the firm's stance on the market in general and ask "What do you think about the market today and why?" she says.

HMC also calls on Wall Street when Harvard needs to make its own contribution to the market. The University issues bonds to pay for renovation costs and hires brokers to act as intermediaries in selling the bonds. "In that case they're a client of ours," says Cabot. "If IBM wanted to go out and sell stock, they would have to go to one of these firms. We act like they do in selling debt."

Yet most of the time, HMC is Wall Street's client. Wall Street firms executing transactions for HMC collect a commission on each trade, and the firms compete for HMC business. "Every [Wall Street firm] tries to get as much business out of Harvard or more," says Hilzenrath. In addition to HMC initiating a trade, Hilzenrath says that Morgan Stanley will try to drum up some business for themselves by suggesting investments.

GETTING ATTENTION

"We treat Harvard like a very important client which makes Harvard think well of [our firm]," says another top Wall Street executive. Although Harvard has a medium-sized account in comparison with the larger mutual funds, Cabot says the endowment garners sufficient Wall Street attention. "Obviously we're a large enough account so that it's worth their while." The bulk of HMC business on Wall Street deals with 30 firms.

The business HMC generates for Wall Street firms is quite different from their dealings with most other universities, who leave their entire endowments to the brokers' bidding. Last year HMC spent about $2 million on investment-related services, but if instead of handling its own management decisions Harvard put the entire endowment in the hands of outside investors, costs would run between $8 and $35 million a year, according to a Wall Street businessman.

Cabot says that for Harvard it is "a lot cheaper" to run its own money management firm. He said that putting the endowment in outside management would cost between .5 and .8 percent of total assets, while running the portfolio internally costs less than .2 percent.

Yet when HMC charged Harvard $9.7 million for total operational costs last year, it drained about .35 percent of endowment assets. According to an investment manager in a major Wall Street firm, Harvard could hire an external money manager at the same rate. Yale's cost for having outside management control its $1.1 billion equity portfolio is "certainly lower" than the .5 percent Cabot suggested, says David Swenson, director of investments at Yale.

Whether or not hiring outside managers ultimately would cost less than HMC depends on the endowment's performance. "If it costs the University less to put all the assets in external management and performance is no good, that doesn't prove anything," says Cabot. While a majority of investment managers underperformed the Standard and Poors index of 500 stocks this year, Harvard's stock portfolio outperformed the market benchmark, says Cabot.

Managing an endowment internally is a question of a university's philosophy, says Potter. "Do you want to run your own business or hire somebody to do it for you?"

GIVING MONEY TO OTHER MANAGERS

And the university with the nation's second largest endowment has decided to let someone else have a go at its funds. The University of Texas endowment, which was worth $2.9 billion at the end of 1985 compared to Harvard's, which was $3.2 million at the time, had been run entirely in-house until 1981. Then the Longhorns decided to put 10 percent of their portfolio in the hands of external investors. "Managers have a style of how they run investments," says Michael Patrick '65, executive vice chancellor for asset management at UT. "We decided that we wanted to supplement the way we manage money with another style."

But stock performance barely budged under external control and last November, UT switched to different money managers. "We need ultimately those managers to do better than ourselves," says Patrick, who attended the College and Business School before becoming top moneyman at UT.

Although UT's success with new investors won't be apparent for another three or four years, Patrick says the external brokers "appear to be competitive with our internal staff."

Other universities have found that external managers are more cost effective. According to Allen, universities with smaller endowments often split up their assets among many money managers or handle part internally and the rest externally. As a university's endowment grows bigger, it can afford higher overhead costs and justify creating a partial in-house management team, says Swenson.

"A lot of organizations do [management] internally and hire outsiders for what they don't have the ability to do," says Morgan's Potter. "Harvard has a big enough endowment that it can afford to do a lot [of management] themselves. What's right for Harvard may not be right for Yale."

The New Haven school, with the nation's fourth largest endowment, runs its money with a combination of both internal and external management. Eight outside managers play the stock market for 75 percent of Yale's funds, while a 15-member in-house investment team directs real estate and bond management. Swenson says that Yale's endowment "is generating a high return by hiring outside firms with expertise." Yale's endowment climbed at over 23 percent last year, at about the same rate as Harvard's funds. Yale will not be managing more of its money internally in the foreseeable future, says Swenson.

And in maintaining the difference between Cambridge and New Haven, Harvard has no plans to manage its money externally in the near future, certainly not when its pays so well.