Rocketing Returns

Propelled by an astonishing 413 percent gain on its venture-capital assets, Harvard Management Company (HMC) reported a 32.2 percent return on investments, after all expenses, for the fiscal year ended June 30. Including donations received from the end of the University Campaign, and subtracting income distributed to support Harvard's academic operations, that brought the market value of the endowment to approximately $19.2 billion--a bracing increase of $4.8 billion from June 30, 1999.

Beating the Benchmarks

To put that in perspective, Harvard's endowment totaled approximately $4.7 billion at the end of the 1990 and 1991 fiscal years. Although accounting changes make those figures not strictly comparable to the current $19.2-billion value, the trend is unmistakable: during the past decade, the endowment quadrupled. The effect on University finances is equally pronounced. After representing about 17 percent of income in the late 1980s, distributions from the endowment have risen swiftly of late, to more than $550 million in the fiscal year ended June 30--about 28 percent of revenue. At a time of slowing growth in tuition income, and relatively modest gains in sponsored-research funding, endowment distributions now fuel Harvard's fiscal engine.

Returning to investment performance, HMC has achieved higher returns in only one year (1983) since it was founded in 1974. The 32.2 percent gain exceeded HMC's "policy portfolio," its benchmark for its 11 asset classes, by 13.6 percentage points--twice the previous best performance--and exceeded the median results of other institutional funds with $1 billion or more in assets by 21.8 percentage points. In theory, as a fund like Harvard's endowment gets larger, superior performance ought to become more difficult.

For all his delight in the aggregrate investment results, HMC president Jack R. Meyer, M.B.A. '69, emphasized other aspects of the endowment's position. The venture-capital gains, he noted, reflect both tremendous returns on investments and tremendous distributions from the external managers who oversee these funds for Harvard. As those investments are cashed out and redeployed across the endowment's portfolio, it is somewhat insulated from subsequent repricing of venture-capital and technology-stock valuations that he termed "pretty scary." Combined with the recent very quick distributions from venture investments, compared with historical norms--a "somewhat reassuring" development, he added--that means Harvard's venture-capital portfolio has "already been a success" no matter what happens now in the public-securities markets.

Second, he said, Harvard's investments are "more diversified than ever." In recent years, for example, HMC has steadily decreased its allocation to domestic equities while creating significant new investment categories such as absolute return (hedge funds) and inflation-indexed bonds, which together account for 12 percent of the overall asset allocation.

Finally, and most important, Meyer said, "We're adding value across asset classes on a consistent basis." Indeed, following a disappointing 1999, when HMC's fund managers fell 6.7 percentage points short of their benchmark, in fiscal 2000 nearly every part of the portfolio shone. Emerging markets trailed the benchmark by a small percentage, and inflation-indexed bonds exactly matched their benchmark rate of return. All other asset classes excelled (see chart), including foreign equities (25.9 percent return versus the benchmark 16.6 percent); private equities, including venture capital and leveraged buyouts (155.2 percent versus 52.4 percent); and commodities, especially oil and gas investments (49.9 percent versus 35.9 percent).

Ever cautious, Meyer emphasized, "We don't expect this level of returns to persist." His annual letter to the Harvard community again sounded the note that negative returns are possible--a result last recorded in 1984, following HMC's high-water mark in 1983. However, endowment managers' real fear, he said, is not the threat of one bad year but the specter of a period like 1972 to 1981, when stagnant investment returns, high inflation, and continued spending to support University operations eroded the real value of Harvard's endowment (and everyone else's) by 40 percent. For now, nothing makes him that pessimistic. Looking ahead, he said, 10 percent or lower rates of return could be the norm. "Earning 100 basis points over the policy portfolio" over the long term, he said, "would make me a happy man."

The Corporation will decide this fall on the endowment distribution for the fiscal year beginning next July 1. But it is safe to assume that it will consider a larger-than-routine disbursement, perhaps along the lines of the 28 percent ($95-million) boost authorized for fiscal 2000. Routine increases in the distribution have been more in line with the 8 percent or so effective in the current year.

Whatever the Corporation determines, the president who succeeds Neil L. Rudenstine next July 1 will take office harvesting the fiscal fruits of a remarkable decade of fundraising and investments. If Meyer is right, however, she or he ought not count on the endowment quadrupling again, to $80 billion, by 2010.

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