Harvard Returns 8.1 Percent in ‘Disappointing’ Fiscal Year 2017

UPDATED: September 19, 2017 at 11:40 p.m.

Harvard Management Company returned 8.1 percent on its investments in fiscal year 2017, a “disappointing” performance the firm’s freshman CEO called “a symptom of deep structural problems at HMC.”

The returns—which brought the value of the endowment to $37.1 billion—are the worst of almost 20 institutional investors who have released their figures for fiscal year 2017. The figures released Tuesday are the first under HMC’s CEO N.P. Narvekar, whom Harvard hired last year in an attempt to rehabilitate the University’s beleaguered investment arm. HMC has struggled in recent years, losing almost 2 billion in endowment value and continually pulling in behind its peer investors.

In a letter announcing the returns, Narvekar—who previously oversaw Columbia’s investments — did not mince words about this year's comparatively lackluster returns, promising to “reposition” the firm over the coming years.

“Our performance is disappointing and not where it needs to be,” he wrote. “The endowment’s returns are a symptom of deep structural problems at HMC and the resultant significant issues in the portfolio.”

“It is an unfortunate truth that the issues that have impacted HMC and its performance in the past will continue to negatively impact returns in the near term and will require time to overcome,” he added.

Harvard’s endowment—the largest university endowment in the world—is used to fund a number of operating costs and ensure that Harvard has funding for the foreseeable future. About a third of the University’s annual operating budget is drawn from the endowment, though its schools are dependent to different degrees—the Faculty of Arts and Sciences, for example, received about half its funding from the endowment last year.

The returns for fiscal year 2017, though a marked increase on the negative 2 percent Harvard returned the year prior, continue to lag behind those of its peers. In addition to Dartmouth, MIT and the University of California system reported 14.3 percent and 15.1 percent, respectively. Grinnell College, a small private school in Iowa, netted 18.8 percent on its investments for the year.

Narvekar, the Management Company’s fourth CEO in a decade, has sought to make sweeping changes at HMC to improve the endowment’s performance since his appointment in December. After a quiet review process during his first month at the helm of the firm, he made a striking announcement: by the end of the calendar year, he would lay off more than 100 the firm’s employees and shift to a more “generalist” investment model.

HMC had long retained an unusually large internal staff of around 230 people. It invested its money through a mix of internal and external managers in a “hybrid model” that came under increasing scrutiny as the firm failed to keep pace with the performances at Yale, Columbia, Princeton, and the other peer schools.

HMC’s trailing performance has worried University President Drew G. Faust, who last year warned the low returns would “constrain” budgets across the University for years to come. That rang true last year when the Graduate of Arts and Sciences, citing HMC’s low returns, cut the number of graduate students it accepts by 4.4 percent. Then, graduate students and professors learned they would receive smaller pay increases that were outpaced by the rate of inflation. Harvard also faces a number of financial challenges amid potential decreases in federal research funding.

Still, Paul J. Finnegan ’75, the chair of HMC’s Board of Directors and the University’s treasurer, praised Narvekar’s leadership, writing that he is “making excellent progress in reorganizing HMC to ultimately improve investment performance.”

“The HMC Board of Directors is fully supportive of these efforts and the time required to reposition HMC so that it can perform up to our collective expectations,” Finnegan wrote. “We are confident Narv has the right strategy that will deliver in the years ahead.”

A Natural Performance Drag

In some ways, the underwhelming performance was part of Narvekar’s longer-term plan, a financial bloodletting that he’s betting will improve the firm.

In the past year, HMC has sought to offload some of its natural resources assets, which returned negative 10.2 percent in fiscal year 2016. Over the summer, the Wall Street Journal reported that the firm had sold some of its natural resources assets at a marked-down price in an effort to rid Harvard’s portfolio of the struggling investments .

Those markdowns impacted the performance of the endowment for fiscal year 2017, Narvekar said.

“The HMC Board of Directors took some markdowns on value prior to my arrival, and we have taken more markdowns in fiscal year 2017, which meaningfully impacted our results,” Narvekar wrote. “At this stage, however, while most assets remain attractive, a few have significant challenges.”

He added, though, that “markdowns do not imply sales,” and that also HMC sold certain assets above their valuations during the fiscal year. Additionally, if the University decides an asset may be profitable in the future, it will hold onto those assets.

Charles A. Skorina, a financial headhunter, said Narvekar was smart to dump natural resources assets that were no longer viable as soon as possible—even if he had to do so at a lower price.

“There’s no good time to take a loss, but there are less bad times than others,” Skorina said. “If you’re going to release bad news, do it early in your tenure. And if you’ve got other things in the portfolio like public equities that’ve done well, then it looks less bad than it would’ve a year down the road.”

The natural resources team at HMC is one of the few that will remain in-house, and, according to Narvekar, is outfitted with new team members who will “reposition” the portfolio over the course of the next few years.

'Deep Structural Problems'

Narvekar took his position at Harvard with the hope of implementing a number of changes and restoring Harvard’s perch atop the world of educational investors. And while the changes may take years before they fully set-in, Narvekar has moved quickly, detailing in his letter Tuesday the progress of his plans.

He announced in January that he would slash the firm’s internal staff nearly in half, laying off about 100 people by the end of the calendar year. HMC would also outsource the majority of its assets to external managers by the end of the fiscal year.

As of June 30, many of those changes have already been implemented, Narvekar wrote in his letter Tuesday.

Federal Reserve Bank of Boston - HMC Office
Harvard Management Company is housed in the Boston Federal Reserve building.

“In a perfect world, we would have moved through these changes over a much longer period,” he wrote. “However, given the time needed for these changes to impact results, the HMC Board of Directors and I strongly believe that HMC will be in a far better position by moving quickly. We have done so.”

HMC’s relative value and equity teams have been shut down completely and outsourced. The credit team, though currently operating in-house, is expected to spin-off from the firm in the nearby future, as is the highly-successful real estate team. Consistent with his announcement in January, Narvekar wrote that HMC “is working to execute a mutually beneficial agreement” with the teams that will spin off from the firm.

Narvekar wrote in his letter that leadership turnover at HMC has complicated the turn to external managers and depressed the firm’s returns over the past few years.

“When I departed Columbia, ten of our team members had worked together for eight years or more, with most of us in excess of ten years,” he wrote. “By contrast, HMC has experienced several leaderships changes during a relatively short period of time. I believe the strong long-term performance of several endowments with consistent senior teams is not a coincidence.”

He also took aim at the firm’s internal culture, which has been described by employees at the firm as “lazy,” “fat,” and “stupid” in a review conducted by the consulting firm McKinsey and Company.

“Besides the obvious need to strive for excellence and to conduct ourselves with integrity, we seek to build an organization that is highly collaborative and less hierarchical than previously structured,” Narvekar wrote.

Narvekar wrote that the firm will continue to move towards a “generalist” investment model, where portfolio managers collaborate to work for the health of the overall endowment. To encourage this, the firm has revised its compensation framework to tie the interests of its managers to the interests of the entire firm. For fiscal year 2018, compensation will be tied directly to the performance of the entire endowment.

HMC will also work to identify an appropriate level of risk for the University—a process Narvekar wrote may take years. He again warned that comparing Harvard’s investment strategy to other universities’ is “not productive,” and argued the practice “contributed meaningfully to the challenges experienced by leading endowments during the financial crisis.”

Despite the years of difficulties, Narvekar is optimistic about the future of the firm.

“As a fourteen-year leader of a highly successful endowment, it is my firm conviction that a talented and skilled team supported and guided by the right organizational and investment culture, and properly incentivized, will overcome legacy issues and produce strong long-term results,” he wrote.

—Staff writer Brandon J. Dixon can be reached at brandon.dixon@thecrimson.com. Follow him on Twitter @BrandonJoDixon.

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