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How Harvard Did It

How Harvard Did It

Below is a summary of how Harvard and Yale endowments did so well in the past decade.  May I suggest that it is excellent reading.  Diversification away from U.S. equities to global equities, commodities, hedge funds, venture capital and buying raw commodities, for example trees in the ground.

I bring it to your attention because it mirrors the approach we take global with global investments, including stocks from various countries, gold, base metals and energy.  We look for exceptional returns and go where they are.  It sounds easy, although it is not easy to implement.  We believe it is the reason for our success.

Thanks to my good friend Barry Sahgal for sending me the article.

How Harvard Did It

By: Adam Smith
October 5, 2007

The Harvard Management Company, which runs the University’s $34 billion endowment, has reported to its “interested parties” a net return of 23% for the year ending June 30, 2007.  That performance gave Mohamed El-Erian, the smooth, mustachioed Egyptian who had run Harvard Management for 18 months, a nice sendoff for his return to Pimco.

I qualify as an “interested party” and hence got the information perhaps a few hours ahead of the public, because I was once on The Harvard Portfolio Committee.  That was three decades ago.  I was appointed because I had been elected a director of the Harvard Alumni Association and, when they parceled out the committee assignments, they put me there.

I remember entering the conference room at my first meeting with a sense of awe.  My fellow committee members were (except for me) very blue chip.  There was Stanley Surrey, silver of hair and square of jaw, famous professor of taxation at The Law School.  There was Abe Collier, chairman of “The New England,” not New England Mutual Life Insurance Company, “The New England.”  All my colleagues seemed like that.

But I soon learned that The Harvard Portfolio Committee didn’t really do anything.  The portfolio was actually run by State Street Research, and that was run by Paul Cabot.  We would meet him once or twice a year, a gnarled, bald old Yankee who wore a black stocking cap even indoors and was given to Yankee aphorisms like “every tub on its own bottom.”

Paul Cabot had two-thirds of the portfolio in domestic equities and one-third in bonds.  He didn’t seem to want to hear much from The Harvard Portfolio Committee.  We were left to debate social issues, like whether we should divest from South Africa.  I always thought it was funny that when the era of Paul Cabot came to an end, the University searched through its hundreds of thousands of alumni, its business school, its law school, and came up with…Walter Cabot, who served until 1990.

In 1990, Jack R. Meyer arrived.  He was a graduate of the B School (the Harvard Business School), worked at Brown Brothers and the City of New York, and ran the endowment of the Rockefeller Foundation.

Jack Meyer was also a friend of David Swensen and the two talked frequently.  Swensen had a Ph.D. in economics and taught finance at Yale.  He had taken over the Yale endowment in 1988.

Quite simply, these two friends had a broader vision of what constitutes investing and how to implement it.  By the end of 1991, Harvard’s two-thirds in domestic equities shrank to 40% and 18% in foreign equities emerged.  Domestic bonds dropped from 27% to 15%, with foreign bonds at 5% and high yield at 2%.  Commodities also made an appearance at 6% and a new category, real estate, was 7%.

Harvard became the first institutional client of Kleiner Perkins.  This is one of the reasons it is so hard for you and me to duplicate the experience of Harvard.  If you want to be on the ground floor with exposure to the best ideas in Silicon Valley, it helps to be in Kleiner Perkins I and not Kleiner Perkins XXXII, or whatever advanced Roman numeral is open to the peasantry.

Harvard at one time — maybe it still does — had 11% of its assets in trees.  Not timber companies, trees.  Harvard Management figured there was a real return of 7.5% to 8% in trees, and it had three lumberjacks on its payroll.  And if you are convinced that trees, real trees, are a solid long-term investment, you can, of course, leverage your investment quite handily.

By June 30, 2007, domestic equities were 12%, foreign equities 11%, emerging markets 8% and private equities 13%.  Also, “Absolute Return and Special Situations” were at 17%, nearly the equal of domestic bonds and stocks.  And generous incentive compensation was part of the architecture, unusual for a university.

All of this did not come without squawks.  Jack Meyer’s compensation of $6.9 million came under criticism from the alumni.  Did Harvard not have Nobel Prize winning professors, tenured and honored, making perhaps $250,000 a year?  Maybe the alumni would not respond to the fund drive quite so handily?

Jack Meyer never flinched at performance fees.  It was results Meyer looked for, the net return to the endowment.  One year he paid a bond trader, David Mittelman, $35 million.  That didn’t go over in a university atmosphere.

There were stumbles more embarrassing.  One of Harvard’s managers left to start a private hedge fund, Sowood Capital, and Harvard became a large investor.  Sowood went belly up in the subprime fiasco, and Harvard Management dutifully reported the losses would translate into a loss of about 1%, but it happened in a good year.

Meanwhile, in New Haven, David Swensen was compounding Yale’s endowment at close to 18% a year for the last decade.  These results did not go unnoticed, especially when Swensen, goaded by my onetime colleague, Charley Ellis, wrote a book called Pioneering Portfolio Management.  The damage was done.  Every university and endowment in America said, hey, why don’t we do that, like Harvard and Yale?

No longer did hedge fund managers and private equity people have to thread through family offices and wealthy individuals.  Now, they had the whole world of endowments and foundations willing to pay up for performance, if only they could have a record like Harvard and Yale.  They were helped along by marketers like Cambridge Associates.  Many of the young hedge fund managers had no idea of the history that had made their wealth so relatively easy.

Harvard is “immortal” or as close to immortality as you can get in our civilization.  It competes on every level, for the brightest students, for the most distinguished professors
— and in its endowment management.  But it does not have to meet redemptions.  Once you have the $35 billion, you have it.  There are demands upon it, surely, because faculties and administrations can think of uses.  But you need not fear December 31 and a demand for a large chunk of your funds.  That makes its investment posture and attitude different than you and me. 

Also, Harvard’s endowment is now laced and stitched with leverage.  There was no leverage in the days of Paul Cabot.  I can hear his voice now at the suggestion of it, and I could almost make up a Yankee aphorism.  But if Harvard believes trees return 7.5% to 8% a year, I bet the trees have been borrowed against.

Simple investment in domestic stocks and bonds, as Paul Cabot once did, has diminished to a small percentage of the portfolio, and all the managers to whom the elite universities have turned use leverage in some form, some extensively.  And the operators of the leveraged vehicles get performance fees, because their elite clients are looking for the best return on their capital, and now we are talking about performance fees on a very large amount of money.  That, in turn, incidentally, has an impact on Manhattan real estate.

With some between-the-lines regret, the Harvard report says, “Ever larger pools of private and public investment capital are looking to mimic the ‘endowment approach,’ and while imitation may be the highest form of flattery, such migration of capital will inevitably dilute the potency of the approach and complicate its implementation.”  Among Harvard’s current approaches are “risk management activities (which) benefited from updates in analytics, scenario formulation, guidelines, monitoring mechanisms, and the scope of risk mitigating instruments.”

If you compare the Harvard report to what you see on CNBC every day, the overlap is very small.  CNBC has an entertaining focus on the U.S. stock market presented by attractive young people.  It’s not the world as Harvard sees it.  Harvard has promised to keep us informed with a web site that isn’t quite up yet, www.hmc.harvard.edu.

The Harvard report says future success will depend “on our ability to navigate the journey — particularly the extent to which we can discern and respond to an increasingly fluid and volatile economic, financial and geo-political landscape,” and it urges readers to look on the handsome 2007 return as a “windfall” event.

But, to me, the tone of the Harvard report is as interesting as the facts it reports.  It seems to say, as the British poet Ernest Dowson wrote, “they are not long, the days of wine and roses.”

Copyright © 2007 by ‘Adam Smith.’  All rights reserved.

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