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Billions Left on the Table: Harvard’s Misguided Investment Strategy

By Steve S. Li
By Jonah S. Berger, Contributing Opinion Writer
Jonah S. Berger ’21, a former Associate News editor, is an Economics concentrator in Cabot House. His column appears on alternate Fridays.

For most companies or individuals, a dozen consecutive years of investment failure would bring about a complete rethinking of strategy, if not financial downfall.

Not so with the Harvard Management Company, which shepherds the University’s more than $40 billion endowment. HMC’s success or failure decides if the University can fund pathbreaking research, hire additional faculty in needed fields, build a long-desired student multicultural center, and even keep its lights on.

Yet this past year marked the 12th in a row in which HMC has underperformed the stock market as a whole. In other words, if Harvard were to have just placed all its disposable endowment funds into a simple passive index fund a decade ago and left it there untouched, the University would have saved close to half a billion dollars in bloated salaries for HMC executives and generated billions more in returns.

The irony is that Harvard used to be viewed as an enviable model for consistent, elevated investment returns. Throughout the 1990s and early 2000s, Harvard’s endowment actually outpaced a traditional portfolio of U.S. stocks and bonds by as many as six percentage points a year, better than even many actively managed funds on Wall Street.

At the time, there was so much to go around that a high-level HMC executive could rake in up to $35 million in a single year.

But eventually, the luck — or perhaps short-lived skill — ran dry. The University’s success had come in large part from bets in risky industries like timber that paid off handsomely in the short-term, but ultimately could not sustain such high returns. Similar gambles on quixotic investments in more recent decades — like a massive gambit on Brazilian farmland — have proved financially (and sometimes ethically) disastrous.

Now with over a decade of clear evidence, there’s no excuse for Harvard not to give up its time-worn strategy, one in which managers act more like teenagers trying to short Gamestop than financially savvy and deliberate stewards of the world’s largest university endowment.

In 2017, apparently recognizing that its low returns required reforms, HMC outsourced some of its investment operations, after steering a mostly in-house operation for decades.

But this missed the point almost entirely, a case of shifting the seats on the Titanic without fundamentally altering the boat’s course. If anything, it may have only solidified and even exacerbated Harvard’s misguided strategy of trying to get fancy with its money, whether trading stocks or dipping into risky, alternative investments.

By outsourcing, Harvard appears to be betting that active fund managers know better. In reality, the hubris of such managers is a cause of considerable jest among many financial experts.

In 2007, Warren Buffett challenged the hedge fund industry to a $1 million bet. "Just select a set of at least five funds that match the returns over 10 years of an unmanaged, passive fund, and you’ll receive the $1 million," he said.

“After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?” Buffett asked at the time.

Well, what happened? Sure enough, a confident fund manager accepted the bet and proceeded to lose so overwhelmingly that he handed over the $1 million to Buffett months early.

Harvard’s decision to actively invest is hardly unique among large universities or mega-wealthy individual investors. Slightly more than half the U.S. stock market is made up of money from actively managed funds.

But that proportion has dropped significantly over the past decade, as investors have begun to finally abandon their infatuation with hedge funds and other professional investors.

In fact, many smaller colleges — including Carthage College of Wisconsin — have already implemented pretty much this very passive strategy, with predictably positive results. In the decade spanning fiscal year 2007 to fiscal year 2017, encompassing the worst of the Great Recession, Carthage reported a 6.2 percent average annual return.

Harvard? Just a 4.4 percent return. That alone is literally billions in lost money.

In fact, during the financially difficult 2016 fiscal year, the smallest university endowments as a whole outperformed the largest ones, according to the National Association of College and University Business Officers survey. That difference could almost be entirely explained by the large colleges’ higher use of hedge funds and other non-passive investing schemes.

In other words, these small colleges’ experiences dismantle the common argument from supporters of actively managed funds, that, “well, passive index funds work might work fine, but just watch what happens when the economy hits a rough patch!”

A shift to passive investing for the University is far from a new or radical idea. An activist group of alumni from the Class of 1969 has long called for similar reforms.

Having a passive investment strategy and divesting from fossil fuel and private prison companies are not mutually exclusive. In fact, 11 of 12 passive sustainable funds beat the standard S&P 500 index in 2020, showing a large-scale shift towards passive investing could actually help accelerate and justify a quick move away from socially deleterious investments.

Ultimately, Harvard’s current strategy may come back to donors wanting their money to feel safe and closely looked after when they write a check to the University. Just like they might make the mistake of placing their individual assets in the psychologically safe hands of an active manager, they want the University to do the same.

But it is Harvard’s responsibility to do what’s financially savvy above all else. And higher returns will surely speak loudest in the end.

This can’t be a topic broached only a few times each decade, given the hundreds of millions to billions of dollars at stake. HMC leadership should have to justify the organization’s very existence at every turn. The onus should be on them, not on activists from the Class of 1969 or others proposing a sensible path forward.

Harvard’s donors deserve it. Harvard’s faculty and staff deserve it. And Harvard’s students deserve it.

Well, what are they waiting for?

Jonah S. Berger ’21, a former Associate News editor, is an Economics concentrator in Cabot House. His column appears on alternate Fridays.

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