The compensation for the most highly paid endowment investment managersthe subject of criticism and debate in recent yearstook on a different look when Harvard Management Company (HMC) released its report for the fiscal year ended June 30, 2006, just before Christmas. Compared to the three prior fiscal yearswhen HMC’s performance-based pay system yielded annual payments of as much as $18 million, $25 million, and $35 million for individual fixed-income managers (see “Money-Manager Compensation,” March-April 2006, page 69)the top earnings for 2006 went to timber portfolio manager Andy Wiltshire, who received $2.9 million. Two other portfolio professionals received more than $2 million, followed by real-estate and domestic-equities managers whose payouts were $1.7 million and $1.6 million. President and CEO Mohamed El-Erian, who assumed his post at HMC in February, earned $2.3 million.
The apparent deflation in investment-manager compensation does not reflect any change in HMC’s pay formula, which remains heavily based on investment returns in excess of market benchmarks, sustained over time. (In fiscal year 2005, endowment returns exceeded market benchmarks by 5 percentage points; for 2006, the margin was 3.7 percentage points.) Rather, as the news release guardedly put it, “[T]he compensation numbers…are impacted by transitional factors, including partial year coverage, changes in capital allocations, and initial hiring outlays.”
As reported (see “Money-Management Makeover,” November-December 2006, page 68), the prior senior management of HMC and the fixed-income portfolio team departed in the autumn of 2005 to create a private investment firm; most of the assets they had overseen were then invested passively, simply to match the market. That immediately affected potential manager compensation. Moreover, some of the asset classes in which HMC outperformed during 2006real estate and absolute return, for instanceinclude significant sums managed on a fee basis by external firms, whose compensation is not covered by the figures HMC must report for its own staff.
Newly hired investment professionals began managing money at various points during the year, and none of them has taken on anything like the large sums that were entrusted to their predecessors, whose performance records had been tested in varying market cycles during HMC employment that extended, in some cases, for more than a decade. The pay system recognizes not merely “value added”the performance in excess of market averagesbut also the sums for which each portfolio manager is responsible (“dollars value added,” if you will, a measure of relative and absolute contribution to the endowment’s gains). Thus, even with strong relative returns, a relatively new HMC staffer with a still-small portfolio will not earn the huge performance bonuses that accrued to the senior fixed-income managers a few years ago. This buffering effect may be expected to persist for the foreseeable future. (El-Erian’s earnings, to an undisclosed degree, reflect both the cost of hiring him from the private investment-management industry, and the fact that he was on the job for just part of the year.)
Looking ahead, the internal allocation of capital-management responsibilities, the use of external managers, and changing investment returns seem likely, at least in the near future, to produce compensation reports more like those released last December than like those that attracted so much attention earlier in the decade.