Finding a New Footing

Although summer provided a break from a financial annus horribilis, Harvard continued to grapple with the fallout from the projected 30 percent decline in the value of its endowment assets—and the resulting need to “do business differently,” as President Drew Faust put it (see “Still Harvard”).

Beginning in late June, the University laid off personnel. Faculty of Arts and Sciences (FAS) working groups set about devising the changes required to put the school on a new financial footing. And publications from Barron’s to Vanity Fair focused attention on Harvard’s and other schools’ endowments, a reminder that the institutions remain under heightened scrutiny—and that the investment losses and scenarios for recovery now being quantified remain critical to their future. (For background, see “‘Resizing,’ before ‘Reshaping,’” July-August, page 51, and the financial news archived at


The workforce. Wages, salaries, and benefits account for 48 percent of Harvard’s expenses. Nonunion salaries have been frozen and 531 staff members took an early-retirement incentive during the spring (see “Looming Layoffs,” July-August, page 56). But a June 23 community e-mail from Faust noted, “[W]e nevertheless have more we must do.” That introduced the layoff of 275 staff members, and a reduction in hours for 40 others—predominantly from the ranks of administrative, professional, clerical, and technical employees. 

Some of the individual schools’ decisions illuminated their differing financial circumstances. The Harvard School of Public Health was able to avoid layoffs. (It is the unit least reliant on endowment distributions, just 13 percent of revenues in fiscal year 2008, and most dependent on sponsored-research funding, 73 percent of revenues.) So was the School of Engineering and Applied Sciences.

Harvard Business School (HBS) derived only about 20 percent of its revenues from endowment distributions in fiscal year 2008—and has benefited from a capital campaign, concluded in 2005, that raised more than $600 million. But income from business executive-education programs and its large publishing operation is under pressure from the recession. HBS laid off 16 staff members, but its downsizing is much larger. Combining the 42 people who accepted early retirement with the layoffs and other attrition, the school trimmed its staff of 1,187 (excluding faculty members) by 80 full-time equivalents, and reduced its contractors and temporary workers by another 50 equivalent positions: a 130-person decline.

Harvard Law School (HLS), which relied on endowment distributions for 37 percent of its fiscal year 2008 revenue (about 3 percentage points above the University average)—and itself celebrated a $476-million capital campaign just last fall—laid off 12 staff members. Together with 25 early retirements, elimination of current vacancies, and ending of limited-term appointments, HLS expected its staff to decline by nearly 10 percent. Endowment distributions to the school are now forecast to decline as much as $19 million from the level in the fiscal year that ended this past June 30—more than 10 percent of the current operating budget.


As expected, the cuts fell most heavily upon FAS, which had already absorbed 156 early retirements: 77 staff positions were eliminated, and 15 other workers had their hours reduced. Humanities professors particularly lamented job losses within the Harvard College Library: from an average of some 550 full- and part-time employees, 52 took early retirement, “more than 20” were laid off, and several others had their hours reduced.


FAS restructuring. Dean Michael D. Smith announced in April that he would appoint working groups to address the “reshaping” required to align the faculty’s operations with its reduced resources.

After cutting costs by $77 million, FAS still faces a budget gap of up to $143 million in the 2010-2011 academic year. That is more than 20 percent of its expected expenses this year after excluding about $425 million budgeted for undergraduate financial aid, debt service, and sponsored research. (FAS derived 52 percent of its revenues from endowment distributions in fiscal year 2008, and a higher proportion in the year just ended. It had expected that to grow by $100 million this year; instead, it faces a $50-million reduction—and a further, likely larger cut next year.)

The working groups have now been selected and charged with “embarking on a process to prioritize [FAS’s] academic and intellectual activities to guide further budget reductions and to reshape its programs to be sustainable over the long term” (for the full membership rosters, see Separate groups are examining College student services, College academic life, arts and humanities, sciences, social sciences, and engineering and applied sciences. All six interact with the Graduate School of Arts and Sciences, whose activities overlap all FAS teaching and research. 

In a late-July conversation at University Hall, Smith emphasized the groups’ mandate to “understand what’s core in our different areas” so that “we don’t go backwards on any core functions” as FAS restructures. Although each area is “framed” by financial parameters, he stressed that the groups’ work is driven “intellectually, first and foremost.” They were expected to analyze data during the summer; advance recommendations for community discussion during the fall term; and work with Smith, other deans, and senior administrators through December to prepare plans for the fiscal year 2011 budget, to be drawn up then.

Smith described other initiatives under way across FAS to improve operations. These include partnering with the central administration on real-estate project planning and management;  pursuing efficiencies in how the libraries work, within FAS and across Harvard; and strengthening information systems and technology—in part to realize savings already identified in the faculty’s announced cost reductions. Given that most major building projects are in abeyance University-wide, Smith said, FAS’s chief capital concern now was being “much more careful” to assure that before any faculty search proceeds, physical requirements (to fit up a scientist’s laboratory, for instance) could be accommodated—preferably in existing space or with modest renovations. And he said analysis continued on the “complicated” issue of whether an effective faculty retirement-incentive program could be designed and financed.

Looking ahead, Smith noted that even as FAS focused principally on priority-setting, it continues to make progress on relatively inexpensive academic goals: creating courses for the new undergraduate General Education curriculum launching this term, for example, and assuring that junior faculty members have the support they need to pursue their research and develop professionally.

Balancing FAS’s daunting fiscal constraints and its aspirations will likely be important themes of the dean’s annual report, covering the past two years, and his forward-looking letter to the faculty, both expected in early autumn. In discussing the challenges with alumni, Smith said, he has taken heart from their reaction: “Nobody likes to see us struggling. They’ve been extremely supportive of what we’re trying to accomplish.”


The endowment. “The Big Squeeze,” the cover story in the June 29 issue of Barron’s, the financial weekly, detailed the extent to which the endowments of Harvard, Yale, Stanford, and Princeton are invested in relatively illiquid assets (private equity, hedge funds, real estate, commodities), and offered sobering estimates of their likely depreciation. 

Reporter Andrew Bary then calculated the extent to which each institution has made commitments, through its investment partnerships, to advance funds in the future to the respective managing partners for those assets. He figured that Harvard has $11 billion of future commitments to such partnerships (extending over the next decade; see “Leverage and Liquidity,” July-August, page 52), and an endowment now valued at $25 billion. Bary reported that Yale has $8.7 billion of future commitments, and Princeton $6.1 billion—looming larger in relation to their current endowments’ values than is the case at Harvard. (Stanford’s future commitments were not disclosed.) His forecast: “The brutal market of the past year could mark the end of the alternative-investment boom,” as endowment managers “move back toward the traditional stocks and bonds that once were staples of their investment portfolios.”

The August Vanity Fair, released on July 1, covered some of these topics, more colorfully, in Nina Munk’s long article “Rich Harvard, Poor Harvard.” It chronicles what Munk termed “overbuilding,” “extravagance,” “flawed investment decisions,” and an atmosphere of “recriminations and backbiting” at a time when “Harvard is in trouble, and no one can decide who’s to blame, or what to do next.”

The guilty pleasure of reading such retrospectives aside, they prompt some observations about the endowment past and present, and key questions about its future—and the resulting constraints on the University.

First, Harvard Management Company’s (HMC) diversified portfolio, with its significant use of alternative assets, has long yielded high returns (see “The Endowment Manager’s Perspective,” for some of the data)—outpacing gains from conventional stock and bond investments, and weathering the shock losses of the past 12 months better than many other investments.

Earlier this decade, as the endowment grew rapidly and as alternative-investment options proliferated, HMC’s appetite appears to have increased. In part as HMC professionals left to set up their own firms, the share of endowment assets managed in-house declined from 70 percent to 30 percent. According to University financial statements, the endowment was valued at $25.9 billion at the end of fiscal year 2005, and future commitments to investment partnerships during the ensuing decade totaled $3.4 billion. Shortly thereafter, HMC president and CEO Jack Meyer and the large fixed-income team departed to form their own firm. The multibillion-dollar pool of assets they had managed was temporarily parked in cash instruments—and then, apparently, rapidly redeployed, consistent with the strategies put in place by Meyer’s successor, Mohamed El-Erian (who in turn returned to his private firm in late 2007). In the following fiscal years, the University reported these endowment values and future commitments, respectively:

   2006: $29.2 billion and $7.2 billion

   2007: $34.9 billion and $8.2 billion

   2008: $36.9 billion and $11 billion

Thus, as the endowment value grew 42 percent from fiscal year-end 2005, future commitments to asset-management partners more than tripled. The challenges are now twofold: funding those commitments when liquid resources are limited (in part because past investments are not generating significant cash distributions to Harvard and other limited partners); and determining whether new investments will now earn the returns anticipated when the commitments were made.

Whatever decisions were made then—and no Harvard leaders are dwelling publicly on the past—the endowment managers and the University, of necessity, are pursuing different courses today. HMC will report its results for fiscal year 2009 in mid September. The endowment overall should be more liquid, but the proportional weighting of certain illiquid assets could increase, depending in part on sales, purchases, and performance throughout the portfolio. (In addition to president and CEO Jane Mendillo’s comments here, she hinted about changes in a May interview with the Gazette; see Over time, there may be measurable changes in the “policy portfolio,” HMC’s model for allocating investments among  asset classes.

But it would be surprising to see HMC abandon the strategies that proved successful in the past. For one thing, as Mendillo told the Gazette, “I expect we’ll see some interesting opportunities across the board, for example in real assets—real estate and natural resources—where we are uniquely positioned, given our experienced and pioneering teams,” whose professional ranks have in fact been bolstered by recent hirings. For another, the prices of such assets have declined, as have borrowing costs, making the potential returns on new investments much more attractive than at this time last year. The huge California Public Employees’ Retirement System has indicated that it would increase its use of private-equity and hedge funds, commodities, real estate, and other assets, for just these reasons.

In the very near term, legacy investments in real estate, some commodities, and private equity may hold returns on the endowment below HMC’s long-term goal of 8.25 percent annual gains. And therein is the continuing challenge to the University’s budgets.

Reducing endowment distributions by 8 percent this year and a similar amount next year necessarily means cutting spending much less, and much less rapidly, than the value of the investments themselves sank last fiscal year. Arithmetically, that pushes the rate of distribution up—to a forecast level above 6 percent this year. If endowment returns are lower than that, its value would decline further during the year in nominal terms (absent any gifts received), and even further accounting for inflation.

So far, Harvard officials have not detailed their long-term assumptions about endowment returns, distributions, and values. But Stanford offers a useful analogy. In a presentation to his academic council in late April, President John Hennessy forecast that if spending were not reduced, assuming 3 percent inflation (below historical experience) and 8 percent investment returns for the next five years and 10 percent after that, it would take more than 30 years for the Cardinal’s endowment to recover to its mid 2008 peak; substantial endowment gifts might cut the recovery period in half. Those trends underlay Stanford’s decision to cut endowment spending (30 percent of revenues) more sharply than Harvard plans to do—10 percent this year and a further 15 percent next—in the hope of beginning to increase the payout again three or four years hence.

It is reasonable to assume that under similar economic and investment conditions, given Harvard’s finances—and the pressure to reduce the payout rate toward a more normal range of 5 percent or so—the beginning of any recovery in endowment distributions here lies at least that far in the future. 


The recession may be abating, and the financial-market chaos that punctuated it diminishing in effect. But the University’s adjustments have only begun. Income from the endowment remains a critical source of revenue. HMC’s experts have to balance new assessments of risk and demands for liquidity against promising investment opportunities—all while watching an uncertain economic environment. And Harvard’s academic leaders face a protracted effort to reduce continuing costs, to find new sources of revenue for immediate needs, and, somehow, to invest in the most compelling opportunities to advance knowledge and learning. It is the most delicate of balancing acts where, as President Faust told her deans, “What we do matters.”

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