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Necessary Change

Endowment success is crucial for Harvard and the restructuring of the underperforming Harvard Management Company is reason for optimism

The consistent failure of the Harvard Management Company to meet both internal and external benchmarks is finally inspiring reform. Last year’s significant loss will have unwanted effects on the University’s budget, and a professional analysis of the company’s management and structure strongly suggests that the company’s consistent underperformance is avoidable. We are relieved that Harvard is finally breaking from the problematic status quo in a drastic overhaul of past investment practices and company management. If Harvard cannot at least match the financial success of peer institutions, it cannot expect to keep its role as a leader in research and higher education.

Harvard’s endowment is the largest in the world, and the magnitude of its portfolio should not be underestimated. Last year’s negative 2 percent return amounted to a loss of $2 billion dollars, which cut into both endowment size and the University’s operational budget. This loss represents the first since the 2009 financial crisis. While this was a tough financial year, there is no denying that HMC fell short. The internal benchmark was a positive return of 1 percent, and the company’s failure to reach it is nothing new. Neither can HMC’s underperformance be adequately explained away by external factors, given that peer institutions like Yale and the Massachusetts Institute of Technology were able to achieve positive returns in spite of the same challenges or at least smaller losses.

Much of the evidence points to a need for serious change. In a critical examination of HMC, the consulting firm McKinsey and Co. found that money managers were taking home large bonuses for exceeding easy targets. Between 2009 and 2014, manager compensation soared and 11 money managers took home $242 million in just five years. Over 90 percent of this sum of money was made up of bonuses that appeared to be awarded when managers exceeded large, moving targets. HMC employees themselves described management to McKinsey as “lazy, fat, [and] stupid.” Even so, the board overseeing HMC failed to tighten standards or more critically survey the situation.

HMC's recent investment strategy—an expensive series of mistakes for the past few years—will finally face a set of justified reforms. Unlike the rest of its peers, HMC has historically used a “hybrid” model for investment, in which both a large internal staff and external money managers are used. Internal staff are responsible for specific portfolios rather than the overall endowment, and the organization of these staff members is complex. Other universities have long been using only external money managers, whose expertise and competitiveness are hard to parallel.

As a commendable yet difficult first step, HMC’s new CEO, N.P. Narvekar, a past manager of the Columbia endowment, will be moving Harvard in the direction of more competitive peer institutions. Half of the 230-person staff will be laid off by the end of the year and those who remain will have their compensation tied to sustained, overall endowment growth rather than the short-term success of their single department.

These changes are dramatic, but they will shift HMC towards a model that has brought success to other universities. We are optimistic that this change will ameliorate the stagnations and losses of the past and put Harvard back on a financial path that will allow the University to uphold the highest standards of education and research.

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