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Harvard Endowment, Largest in Higher Education, Plummets by 27%

Largest ever single-year decline brings endowment's value to $26 billion

By Peter F. Zhu, Crimson Staff Writer

Harvard’s invested endowment assets took a 27.3 percent hit this past fiscal year, amidst an economic maelstrom that Harvard Management Company CEO and President Jane L. Mendillo called “very likely the most challenging period in modern times for the financial markets as well as for the Harvard portfolio.”

The decline brought the total value of the endowment as of June 30 down to $26 billion—on par with 2005 levels—after reaching almost $37 billion in 2008. The negative investment returns, combined with donations received and money paid out for operations, pushed the endowment’s total value down by $11 billion, or almost 30 percent.

Despite the losses—which were more than the total endowments of any other schools except Yale, Princeton, and Stanford—Harvard’s endowment remains the largest in higher education.

“[W]e saw extreme uncertainty in our economy and a level of volatility and dysfunction in many types of investments that went well beyond all previous experience,” wrote Mendillo, who took the helm at HMC only last summer. The decline—the largest ever experienced at HMC, which manages Harvard’s endowment—was not unexpected, and administrators have been planning for a 30 percent decline since December. Many peer institutions have been anticipating similar losses.

The unprecedented drop has dramatic ramifications for Harvard’s schools, some of which rely on annual payments from the endowment for more than half their income. The Faculty of Arts and Sciences, the University’s largest school and home of Harvard College, drew 52 percent of its revenues from the endowment last year. Planning for a precipitous drop in endowment size has already resulted in $77 million in budget cuts at FAS, and administrators are looking to cut another $143 million this year from a budget of just over $1 billion.

Mendillo emphasized in the endowment report released Thursday that the portfolio is “well positioned” to seize on new investment opportunities and to support University operations. But the report also supplies telling details about the brutal losses sustained by HMC since last July—losses that in many cases exceeded those of standard benchmarks. Possible investment policy missteps that exacerbated the effects of the global financial crisis on HMC, such as the maintenance of an insufficient cash reserve, are mentioned prominently as well.

Absolute return investments, which include some externally managed funds and made up 18 percent of the portfolio at the start of the last fiscal year, fell by 18.6 percent, or 5.4 percent more than the benchmark set by HMC’s board. The value of externally managed private equity holdings, representing 13 percent of the portfolio, dropped by a staggering 31.6 percent—nearly 8 percent more than the benchmark.

“With a few notable exceptions, nearly every asset class did poorly,” Mendillo wrote. “While diversification has been a mainstay and a driver of the portfolio’s return over the long-term, the benefits of diversification did not bear out [in 2009].”

The S&P 500 index fell roughly 28 percent during the period addressed by Mendillo’s letter, while peer investment groups as measured by the Trust Universe Comparison Service saw a softer median loss of 18.2 percent.

As a whole, the endowment performed 2.1 percent worse than the Policy Portfolio—a theoretical portfolio set by HMC specifying allocations and setting performance goals among a mix of asset classes. But certain individual assets have performed well. The report noted that the value of Harvard’s real asset holdings fell by 37.7 percent—slightly less than the benchmark—and that internal emerging markets and international fixed income teams outperformed their benchmarks as well.

As a result of this year’s broad underperformance, “a substantial number” of portfolio managers have had portions of their bonuses earned in past years “clawed back” by HMC, the report said, although it did not provide more specific figures. HMC, which has been criticized for its multi-million dollar compensation packages in the past, typically rewards managers for adding value and outperforming benchmarks. But it also withholds large portions of the bonuses over subsequent years in order to emphasize long-term growth and protect against excessive risk-taking. The report said that a small group of managers who outperformed markets would be receiving bonuses this year.

Mendillo partly attributed the endowment’s underperformance to “complications” within the portfolio existing before the financial crisis, including “recent over-sized commitments to illiquid asset classes; within asset classes, a larger proportion of strategies with long holding periods; [and] a lack of ready liquidity in the portfolio to meet our obligations along with the needs of the University.”
For years, Harvard has been the subject of scrutiny—and idolatry—as its endowment consistently generated double-digit yearly investment returns, largely due to its heavy exposure to alternative asset classes, which include real estate, private equity, timber, and other commodities. Such investments added long-term value to the endowment and brought sustained growth in previous years, but also reduced the portfolio’s liquidity—meaning that the University’s assets became more difficult to sell and convert to cash on short notice.

When markets plummeted across the board last fall, Harvard, along with many other investors and peer institutions, sought to reduce exposure to those illiquid, alternative assets and instead boost cash reserves for operations. Private equity holdings are especially taxing since they often require ongoing and continued capital commitments from investors.

“With perfect hindsight we and most other investors would have started this year in a more liquid position and with less exposure to some of the alternative asset categories that were hardest hit during FY 2009,” Mendillo wrote in the report.

In November, media outlets began reporting that Harvard was looking to sell billions of dollars in private equity holdings at drastically reduced prices, and in December, the University sold $2.5 billion in bonds in order to raise cash, refinance short-term debt, and terminate certain investment agreements. (Mendillo has stated in the past that HMC began exploring private equity sales even before the financial world imploded, as part of a larger policy portfolio shift that she implemented upon her arrival.) Thursday’s endowment report said that over the past year, HMC has reduced its payments owed to outside investment firms by roughly $3 billion and raised cash in order to explore “attractive investment themes that we foresee emerging from the crisis.”

Today, HMC’s Policy Portfolio aims to include a positive cash reserve of 2 percent, whereas the University had previously been borrowing a small percentage of additional money to invest—a practice that can augment gains but also magnify losses.

Mendillo said that the Company is now also considering remodeling its portfolio to encourage team collaboration, focus more on internal strengths, and reassess the endowment’s risk and the University’s needs. While overall risk management was “adequate” last year and helped avoid extreme volatility, Mendillo wrote that more is being done now to manage risk and that lessons have been learned, particularly that “the risk tolerance of the University needs to be an integral factor” when determining how the endowment is invested.

Nevertheless, HMC will likely hew to the diversified investment model that it has long championed. Mendillo pointed out that even slumping assets such as private equity have delivered high returns when annualized over the past few years. If HMC had simply invested its portfolio in a 60/40 ratio of stocks and bonds 10 years ago, the endowment today would be $18 billion smaller, she wrote.

Mendillo also emphasized that HMC has taken steps this past year to increase flexibility and control over internal and external funds. The report said that she intends to continue using a “hybrid model” of internal and external managers, but that she is not targeting any specific proportion. Instead, she noted that internal management is highly cost effective and that HMC would look to “increase the share of our internally managed assets under the right conditions.”

HMC cut its workforce by roughly 50 employees in February, citing the need to “re-balance and re-engineer” the organization. Since then, the Company has made a string of managerial hires, adding investment experts to several internal teams while appointing new heads of internal and external management from within. Mendillo said HMC has increased its “depth and breadth of talent” over the past year and will continue searching for further individuals with “unique investment insights.”

These recent hires, along with the policy adjustments made over the past year increasing HMC’s liquidity, have laid the foundation for a “solid, innovative and sustainable investment strategy” that gives “ample cause for optimism” over the next few years, Mendillo wrote. But she also called for “realistic” performance expectations over the next several years.

“For Harvard, as for almost every major investor, regaining the market value lost as a result of the recent global economic crisis will take time,” Mendillo wrote.

—Staff writer Peter F. Zhu can be reached at

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