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The History of Harvard's Commencement, Explained

Guardians of the Nest Egg

By Scott A. Rosenberg

There's a conference room on the sixth floor at 70 Federal Street in the heart of Boston's financial district where a dozen investment specialists gather at 10:45 every morning. It looks just like those corporate board-rooms you've seen in countless movies, except the rectangular table isn't as big as you remember, the chairs aren't as tall.

"There's pressure to buy a larger table," says Walter M. Cabot '55, the man who--as president of Harvard Management Co.--runs those daily meetings. "I'm resisting that pressure. I feel that if you get a larger table, then you're going to want to put more people around it."

"We've always had the philosophy that the Management Co. should not be so large that everyone couldn't sit around the same table," says George Putnam, the Harvard treasurer who fathered the University's system of managing its own investments.

"When the company was founded, I felt it was important to keep the number of people small--it's cheap, effective, and lets you focus on the major issues," Cabot says. "The great joy and benefit Harvard has is one account for one group of people around a table."

University and financial leaders say this compactness has allowed Harvard Management to hold on to the talented investment managers who have given the company such a successful record so far. James N. Bailey, managing director of Cambridge Associates--which evaluates the investment performance of Harvard and other universities--says HMC has consistently beaten the market average by 10 to 25 per cent.

The 12 professionals who decide where to invest Harvard's $1.4 billion endowment bring to their conference table information culled from corporate annual reports, investment journals, personal visits to companies, visits to foreign firms, even conversations with Harvard faculty members who know something about economics.

"I don't think you can consider one stock without understanding the industry involved, the national economy, and the world economy," Cabot says. Each HMC partner covers the field or market he knows the most about, and keeps the others up to date at the daily meetings.

The "guts" of these meetings, Cabot says, is a lengthy debate about one company, one industry, or the "asset mix"--the portfolio's ratio of stocks to bonds. One partner will present the case. "Quite often there's an adversary role, just to make sure we get everything out on the table. There's a lot of debate; I think people should be challenged in this business," Cabot says. But, he adds, "You don't have to repeat things. This group has been sitting around this table every day for five years, and a sort of shorthand develops."

After the meetings, partners break for business lunches with company representatives, other investment managers, faculty members, and other sources. "We do a lot of traveling," Cabot says. "We never invest in a company that we haven't first called on, and talked to the senior management and the competitors."

HMC is only six years old. Until 1974, State Street Research and Management did Harvard's investing. The University treasurer at the time, George F. Bennett '33, was also president of State Street. "With the uprisings of the '60s, some felt there was something incestuous about the Harvard treasurer using his own firm to manage Harvard's endowment," Putnam says. Furthermore, since the treasurer both managed Harvard's investments and reported to the Corporation on how those investments were faring, he couldn't distance himself enough to judge the quality of the management. "The treasurer was in the situation of defending his own performance to the Corporation," Putnam says.

Putnam and the Corporation investigated different techniques of managing investments, and decided on an independent, private management company devoting its entire attention to Harvard--if they could attract the investment talent they wanted. They could, partly because 1974 was not a banner year for the financial community, "partly because Harvard is Harvard, and partly because managers could get out of the cut-throat Wall Street world and work for an institution that they find morally and socially uplifting," Putnam says.

The University has also found it cheaper to run Harvard Management than to pay outside managers, Putnam adds. This year's HMC annual report says its salaries are "comparable with other first-line institutions," but goes on to say the cost of running the company is one-third of the average in the field.

HMC attracted and held onto an above-average group of investment specialists because it gave them a chance to spend all their time making specific decisions on which account, Harvard's $1.4 billion endowment. They don't spend much time on internal administration because the company is so small, and they don't spend any time on attracting more business or customers because the Corporation won't permit it. "They get to spend 90 or more per cent of their time on the fun part of it," Putnam says. In other investment firms, "as you move up in this field, you normally end up doing more administration and marketing and less day-to-day investing," he adds.

When Harvard Management began, five independent managers took over 10 per cent of the endowment to give the Corporation a means to judge HMC's performance, and so HMC itself could take advantage of the know-how of larger outside firms. Only three of those five firms still handle any Harvard money, though; one merged, and another wasn't doing the job right, according to Putnam. Today HMC uses outside talent mostly in specialized areas--for example, in its decision to commit money in venture capital (loans from an investor to a new business in hopes of a high return). "We didn't want to do it in-house, so we went out and gave the five best venture capital managers a portion of Harvard's money to manage," Cabot says.

HMC works within broad guidelines set by the Corporation, but there's almost no Corporation interference in HMC's day-to-day decisions. Putnam gives the Corporation a list of HMC's transactions every week. "I try to be able to answer questions, but there are very few questions," he says. If HMC's performance began to decline, he adds, the Corporation would not try to interfere in specific investment choices. "We would rather make personnel changes, switch some people around," he says.

"When you hire a manager you have to stick with him. If you meddle too much, you won't know whether the results are yours or his," Putnam says.

Private management companies for universities like HMC are rare; most colleges use outside firms. Jerald L. Stevens, Yale treasurer, says Yale splits its endowment up among five external managers. "We have contracts where we hold them to a management fee and to targeted results." Stevens says. "We don't anticipate moving to a Harvard model," he adds.

Stevens agrees that HMC's set-up helps keep talented managers. But, he says, "There's a possible disadvantage in not having the flexibility to decide that someone--no matter how much time they're spending--isn't doing a good job. It's a different kind of decision to say to someone, 'We don't like you and we're going to fire you,' than to tell a company, 'We're going to move to a different company.'"

One reason Harvard can attract the kind of huge gifts it is counting on during its five-year, $250 million Harvard Campaign is its "good aura of investment management," Putnam says. "Alumni will only give when they think their money will be managed well--people will set up trust funds for Yale," putting a gift in a private manager's hands and sending Yale the interest, he says. But he adds that Yale's "aura" is worse than it deserves.

The strategies that have served HMC well so far and that have given Harvard its "aura" depend on optimistic expectations that the American economy will eventually break out of the "inflationary psychology of buying today because it will be more expensive tomorrow," Cabot says. The University invests more heavily in the energy and capital goods industries that thrive in the strong industrial economy Harvard is betting on.

Harvard followed a conservative market strategy through the 1960s, when other investors were taking ever-larger risks, and today--though it remains prudent compared to most private investors--Harvard is buying more stocks. "We think stocks got over-valued from 1950 to 1972, and now there's a pendulum swing the other way," Putnam says. "We're taking this as a long-term opportunity to get some damn good stocks cheap," Cabot says.

No matter what choices Harvard makes in the stock/bond mix, however, and no matter how successful HMC is in increasing annual income from the endowment, inflation stands in the wings ready to devour the most impressive investment record. Even the hundreds of millions the Harvard Campaign will tack on to the endowment will only delay the day of reckoning if double-digit inflation continues. In years of 10 to 12 per cent inflation, like 1974 or this year, the real value of the endowment will fall despite the best record in the stock and bond markets.

The University draws 29 per cent of its income from student tuition, 26 per cent from government funding of research and financial aid, 14 per cent from gifts, and 21 per cent from income on the endowment. The government isn't increasing much, and the endowment remains the same--so students find themselves making up the balance, Putnam says. "We hope the securities market will do well enough to carry its own share," he adds.

If Harvard moved all of its money into fixed-income bonds, he explains, it could easily earn 10 per cent income on the entire endowment each year. But that strategy would leave no way to raise the value of the endowment's principal over the long run. Inflation has chopped the endowment's real value (measured in dollars adjusted for inflation) by half over the past 15 years, Cabot says. So HMC keeps a balance between stocks and bonds within Corporation guidelines of at least 50 and at most 70 per cent in stocks. The mix usually hovers between 55 and 60 per cent--less stock than most universities--but it could rise as high as 70 per cent as HMC picks up new stocks in the depressed market, Cabot says.

This answer to the "asset mix question" is the centerpiece of Harvard's market strategy, but HMC also tries to use its flexibility to experiment in sophisticated fields like stock-lending, arbitrage and options. "These tools are not very well known in the investment business, and we want to know at least as much about them as anyone else," Putnam says.

HMC keeps its lines to other universities open, too, mostly through Cambridge Associates, which pools information from 20 schools. "You get into trouble in this business if you just talk to yourself all the time," Cabot says. Stanford for example, has a successful record investing in real estate development, and Harvard has begun to experiment with venture capital. Cabot says there's no reason for colleges to keep their experiences to themselves.

By mixing such innovation into Harvard's traditionally ultra-conservative management, HMC has outpaced many other schools; it nonetheless remains far behind inflation. Both Cabot and Putnam, however, believe Harvard and its endowment will weather the current crisis. Cabot says inflation should become a more emotional issue. "Eventually, kids will be getting mad not about South Africa, but about the price of lettuce. South Africa is an important issue, but people haven't shaken their fists enough about inflation," he says. If they do, then Cabot believes the government could launch a crash energy development program that would spur the economy, like the space program in the 1960s.

Putnam says if inflation keeps up, Harvard may have to shed its traditional reluctance to share students and programs with other universities. "Harvard's problem is, it tries to be all things to all students," he says. Harvard may eventually have to exchange students with the Massachusetts Institute of Technology in some fields of physics, or with Wellesley in fine arts--"There's got to be more of this exchange; it's silly to have competing departments so nearby," Putnam says.

Major economic disasters might force Harvard to curtail academic programs or pay more attention to the financial resources of applicants. Putnam says, "Things maybe won't work the way we want them, and there might be disasters, but I think we can handle them."

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