Mendillo’s HMC

Following heavy losses, Jane Mendillo charts new course for the endowment

GARY L. NORRIS

The fair value of the university's endowment has increased significantly since 1990, but dropped precipitously during the financial crisis of 2008.

A year after being hired as president and CEO of the Harvard Management Company, Jane L. Mendillo received a present from her staff: the jaws of life.

In that one year, Mendillo had managed to salvage Harvard’s assets from the most violent market crash since the Great Depression, and the hydraulic rescue tool was meant to symbolize Mendillo’s swift rescue effort.

Mendillo had barely moved into her office in the Boston Federal Reserve building since starting the job on July 1, 2008, when financial markets experienced the most serious downturn since the Great Depression.

As some market indices fell more than 54 percent, HMC’s holdings took a serious hit, depressing the University’s endowment value by nearly 30 percent.

But through a series of fast trades, Mendillo managed to extricate the endowment from the most serious effects of the market crash. Now that the dust has settled, Mendillo will begin implementing her vision for the portfolio.

Mendillo’s HMC is a stark break from the company of the past. With the departure of Jack R. Meyer, HMC lost its 14-year veteran leader—who chafed at the negative press coverage of large multi-million dollar salaries but simultaneously quintupled the endowment with double-digit returns.

Today, HMC has repositioned itself to take more responsibility for guaranteeing the University’s budgetary needs, and has abandoned its image as a one-client hedge fund.

Mendillo’s efforts to reduce liquidity risk, reevaluate compensation, and restructure its internal organization are emblematic of a new chapter in HMC’s history in which the CEO has become a more cautious custodian of Harvard’s wealth.

CIRCLING FOR PREY

During Meyer’s reign as HMC’s storied—if somewhat maverick—CEO, a stuffed, toy vulture hung above the trading floor. The vulture was installed after an external hedge fund manager once called HMC a “vulture investor” in a heated dispute.

Indeed, under Meyer’s leadership, the endowment generated hawkish returns and grew nearly fivefold, from $4.7 billion to $22.6 billion to the astonishment of the academic world and to the envy of many traders on Wall Street.

Meyer attributed the fund’s strong returns during that time to aggressive strategies pursued by the company’s internal investment team. At the same time, the fund outsourced some portfolio management to external hedge funds, recognizing market opportunities.

When Meyer joined HMC, 70 percent of the fund was internally managed. When he left, 50 percent was still in-house. Currently, that number rests at 30 percent, according to Stephen Blyth, HMC’s managing director and head of internal management.

Most other universities hand over their endowments entirely to external money managers.

At the time, Meyer said, “I think the endowment actually offers a higher rate of return for the same amount of risk.”

Accordingly, HMC portfolio managers were paid handsomely, with salaries that outpaced any other paid individual in higher education and rivaled some on Wall Street.

But those salaries also contributed to Meyer’s ignominious departure from HMC.

In 2003, outrage erupted among Harvard alumni when it became public that HMC’s two top earners were earning around $35 million per year. Though that number dropped to $25 million in 2004, the scandal over salaries persisted.

“I don’t apologize at all for the compensation system,” Meyer said in a recent interview with The Crimson. “But it was an enormously difficult situation for Harvard. You don’t want the tail wagging the dog, and HMC was the tail.”

Though Meyer said he felt the principles underlying the system were valid, the dispute nonetheless strained relations between HMC and the rest of the University.

“We were a little less involved with people at the University than I would have liked,” Meyer said. The controversy over compensation “tended to poison relationships.” According to Meyer, he would have liked to have a more productive relationship with those across the river, “but we couldn’t because everyone was mad about compensation,”

Openly frustrated by increasing media scrutiny of endowment managers’ salaries and ready to move on after nearly 15 years at the helm of HMC, Meyer left the company to start his own hedge fund, bringing 30 of the 175 staff members with him.

Meyer’s successor, Mohamed A. El-Erian, mused that he inherited a car without an engine, according to an individual with ties to the company.

But Meyer said that he was very conscious of this concern when he departed. Meyer said he assumed that HMC would be moving away from the type of fixed income strategy used by the team he took with him.

“We thought we left it in great shape,” Meyer said.

Mendillo has since enacted changes to the compensation structure to encourage long-term thinking and diligence.

“Everyone who wants to work here knows that our compensation structure has to be uniquely well-aligned with the University,” Mendillo said in an interview with The Crimson. “And if they don’t meet their markers, they stand to lose their bonuses.”

Compensation for many HMC investors is performance-based, and over 90 percent of compensation paid to portfolio managers is variable, based on investment performance, according to a May press release.

Mendillo also made the company’s “clawback” policy more robust, extending the number of years that compensation is subject to review.

Additionally, HMC’s senior management team’s compensation is now linked to performance of the overall endowment portfolio. Caps have been adopted to limit the amount of compensation a manager receives in any year when the endowment has a negative nominal return.

Mendillo admitted that the system was “unusual” but stuck to the promise that “no bonus is earned unless the market benchmark is beaten.”

During calendar year 2009, the top-earner at HMC was Blyth, who received roughly $8.4 million. Mendillo earned $3,498,269.

CRISIS MODE

During the financial downturn, Mendillo and her staff began each day at 7 a.m. with a crisis meeting.

At the time—late 2008 and into 2009—the University’s endowment began to take a turn for the worse as markets plummeted and Harvard’s investments in exotic financial instruments began to backfire. The aggressive investment strategies pushed by Meyer—what inspired the vulture’s placement on a central spot of the trading floor—would turn sour. Now, the company did not need a vulture at the company’s helm but a rescue worker—someone equipped with the jaws of life.

When Mendillo attended her first board meeting in June 2008 as head of the company, the board began to detect the initial signs of catastrophe.

By the second board meeting that September, Lehman Brothers was only days away from its bankruptcy, and its  subsequent demise devastated financial markets.

As the economy imploded, the endowment suffered repeated jolts, fluctuating in value each day by $700 million to nearly $1 billion.

The high volatility intensified transactions and tension on the trading floor and in the company’s hallways as Mendillo quickly unloaded some of Harvard’s private equity holdings in secondary markets, selling at discounted rates as supply overburdened the market and depressed prices.

Private equity—the purchase of a company then restructuring it and trying to sell it at a profit—is an illiquid asset class, as firms can often take five years to implement their reforms.

In her earlier capacity as the head of Wellesley’s investment office, Mendillo had shed Wellesley’s holdings in private equity just months before joining HMC. But those transactions would prove difficult to replicate as financial markets froze and buyers fled from exchanges.

“Literally the first day after I joined, I had a meeting on selling some private equity assets,” said Mendillo.

Though these markdown transactions appeared to be a series of quick-fire sales, in reality it was a calculated strategy to increase immediate liquidity—or the ability to convert investments into cash—and to take advantage of arbitrage opportunities of overpricing of private equity, according to annual reports.

When Mendillo, six months into her post as CEO, stood in front of the HMC board for their first meeting since the low-point of the financial crisis, board members knew much of the news she would report. By the end of the fiscal year, the endowment would plunge sharply, decreasing in value by a stunning 27.3 percent to $26 billion. Though she was about to present the worst returns in Harvard’s history, she remained calm and collected during the quarterly meeting.

“I think Jane has proven to be a terrific leader. She is calm, she is cool, she is rational, she is decisive in a tough spot. She is someone you want with you in the foxhole,” said Glenn Hutchins ’77, a member of HMC’s board and the co-founder of Silver Lake, a private equity firm.

Meyer said that this demeanor is characteristic of Mendillo, calling her “deceptively tough.”

“She is soft spoken and you think, ‘what a nice person.’ But she is very firm in her decision-making and a very good negotiator,” Meyer said.

HMC—which previously had beat out its benchmarks consistently—fell behind those standards by 2.1 percent, and the annual report noted that “with a few notable exceptions, nearly every asset class did poorly.”

Roughly five miles away from the HMC offices, in a packed Faculty Room in University Hall, Faculty of Arts and Sciences Dean Michael D. Smith asked departments and centers to cut their respective budgets by 10 to 15 percent.

Harvard cut budgets severely, laid off 275 employees, and eliminated hot breakfast for undergraduates.

Realizing the extent of its crunch in income, Harvard said that it would “assess its alternatives” with regard to the Allston Science Complex. Finally in December 2009, University President Drew G. Faust announced the University would halt its construction in Allston, and it soon after paved over the site with concrete.

SHIFTING GEARS

To many observers it came as a surprise that the world’s richest university would have to make budgetary cuts in the wake of the financial crisis. The reality of budget cuts brought home the very real impacts of risky investment strategies as it became clear in 2009 that a large part of the budget cuts were required because the endowment returns yielded barely enough cash to meet the university’s short term financial obligations.

With the advent of the crisis, HMC retooled its investment strategy to increase liquidity while still maintaining a similar portfolio of holdings, which translated to a similar market risk.

Higher liquidity results in greater flexibility in serious downturns, granting the University easier access cash in a tight spot. Mendillo said in early 2010 that HMC’s need to know about the short-term resources of the University was “lit up in bright lights” during the financial crisis.

The more conservative strategies were a far-cry from some of the aggressive investment approaches of Meyer’s days.

“Historically, we took the view that endowments could simply focus on long-term financial results, and the University would take care of short-term business,” Mendillo said in 2010. “We know now that it is all shared business.”

That year, Faust formed a new committee to oversee and reevaluate the University’s risk return profile in terms of the University’s changing goals and needs in an effort to tie HMC more closely to the rest of the University.

Partly as a result of more cautious investing, HMC posted an overall 11 percent investment return and the endowment edged upwards from $26.1 billion to $27.6 billion.

According to Meyer, Mendillo gets “high marks” in handling the crisis and personnel difficulties. “No one can dispute that,” he said. “Now she is in phase two, making this portfolio her own. My bet is that she will get good marks in phase two.”

But Harvard’s endowment returns still lag behind its peer institutions. Princeton boasted a 15 percent investment return while Columbia topped the Ivies with a 17 percent yield last fiscal year.

These changing investment strategies mark a dramatic departure from Meyer’s profit-maximizing approach and a shift in philosophy toward focusing on best serving the University’s needs­—even if it means lower but more reliable annualized returns.

“What is more important—beating our peers’ annual returns, or generating long-term growth with manageable volatility?” Mendillo asked in 2010, capturing the friction in evolution of HMC’s identity.

NEW DRIVETRAIN

The exodus of traders that followed Meyer out of HMC left the company’s investment team in limbo. Since Mendillo arrived she has made retooling the company’s administrative structure a priority alongside realigning its investments.

Steady attrition among its portfolio managers, who left one by one to start their own hedge funds, was a major source of concern within the company but began to subside when Blyth, the top internal investor, stayed on.

With Blyth serving as the investment team’s core member, Mendillo recruited new talent to HMC and built up an experienced equity team. Neil Mason, for example, was appointed to the position of chief risk officer.

According to Blyth, Mendillo may be moving away from relying on external money managers, choosing to bolster the internal team to incrementally take responsibility for a greater portion of the endowment going forward.

But Mendillo was not afraid to make necessary cuts, letting go a number of HMC employees to rein in operating costs.

Mendillo’s end goal was to better align HMC to future investment opportunities across the entire market and to bring each of the portfolio management teams into sync, according to a speech she gave in 2010.

In response to its catastrophic year, HMC said it would consider shifting its focus to areas in which it had a competitive advantage, such as fixed income, a field that focuses mainly on periodic real returns like bond markets. Another area that it is focusing more heavily on is real assets, an area that includes investments like gold, land, and other commodities.

As Mendillo now mobilizes to the future—what Meyer called “Phase 2” of Mendillo’s tenure as the head of HMC—she will now mold the portfolio into her own.

Beyond investing more heavily in these two areas, Mendillo hopes to increase expertise in emerging markets.

Apparently overcoming one of the most severe downturns in Harvard’s financial history, Mendillo is optimistic about the future.

“It was a very rocky period for the portfolio, and it was a lot of hard work,” she said. “But we are focused on drawing strong long-term returns where you think that the opportunities lie in the future.”

—Staff writer Gautam S. Kumar can be reached at gkumar@college.harvard.edu.

—Staff writer Zoe A. Y. Weinberg can be reached at zoe.weinberg@college.harvard.edu.

This article has been revised to reflect the following corrections:

CORRECTION: MAY 26, 2011

An earlier version of this article incorrectly stated that Andrew Wiltshire had been hired under Jane Mendillo's tenure as head of Harvard Management Company. In fact, Wiltshire had been working at the firm prior to Mendillo's selection as CEO.

CORRECTION: June 20, 2013

An earlier version of this article incorrectly stated that HMC’s chief risk officer position was newly created when Neil Mason joined the company in 2010. In fact, the position had existed prior to that point.

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